Ken Lewis interview: Bank of America’s next step forward

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Clive Horwood
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In the July 2007 edition of Euromoney, Bank of America CEO Ken Lewis gave a rare in-depth interview. Lewis said: "We are not believers in the build it and they will come mantra. We need to look our shareholders in the eye". "In time, we want to be one of the top five investment banks in the world". More than 18 months ago Euromoney said: "Bank of America is at a tipping point. Ken Lewis is about to face his biggest challenge yet." Little did we know how great the challenge would be. Re-read the story here

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February 2009

As the terrible fourth-quarter results were unveiled, Bank of America started briefing against John Thain, Merrill Lynch’s chief executive. This is always a high-risk press strategy. A public relations specialist comments: "Washing dirty laundry in public is dangerous. Now even grannies in Topeka, Kansas, know that Bank of America is in chaos."


KEN LEWIS IS on the march. The man never seems to sit still. In the last week of June he was due to complete the acquisition of US Trust for $3.3 billion. At the same time, he was battling to secure control of LaSalle Bank in Chicago, for a net consideration of $16 billion, speaking with shareholders, liaising with legislators, fighting competitors.

It’s a typical Lewis moment. Since he became chairman and CEO of Bank of America in 2001, Lewis has transformed the bank. It is now the largest domestic financial institution in the US. It is one of the world’s largest companies by market capitalization. Last year it generated profits of more than $21 billion, making it the fifth most profitable company in the world.


Lewis could be known as Mr Banking in America. The latest targets hardly do anything to contradict the impression.

But Bank of America is at a tipping point. It has built an enormously powerful base from its core markets in US consumer and corporate banking. Now, as that platform nears completion, Lewis and his management must go down a new path – to maintain the firm’s domestic hegemony, but at the same time build out businesses where it has lagged terribly behind its rivals: investment banking and international finance.

Ken Lewis is about to face his biggest challenge yet.

Last piece of the US jigsaw

LaSalle is vital to Bank of America. It’s why, whichever way the opinion of courts in the Netherlands, or fund managers across the globe, finally fall, Lewis is likely to end up with the Chicago-based bank. It clearly means more to him and his bank than to anyone else.

"Our sheer power, size and scale allows us to innovate in ways others cannot. Most banks say that they will use their size and scale to give back to shareholders. We say we will also give some back to the customer in order to grow our businesses and revenues in the longer term"
Ken Lewis


The official line, repeated by Lewis and his CFO, Joe Price, is that Bank of America has a binding contract with LaSalle that it is trying to enforce. No matter whether he buys it from ABN’s Rijkman Groenink or RBS’s Fred Goodwin, you get the clear impression that Lewis won’t take no for an answer.

Here’s why: "Chicago is the final missing piece of the jigsaw in the US. When we have LaSalle, we will be in every market that we want to be in," says Lewis.

That breadth of coverage extends to 31 states in the US, with a total of 56 million corporate and individual customers.

But LaSalle completes more than just the jigsaw. It also makes it impossible to grow further through acquisition in the US. LaSalle will take BofA’s total share of deposits in the US to the very brink of the 10% limit imposed by regulators. (Bank of America already has 14% of the retail deposit base in the US.) Any future growth will have to be organic.

Or else it will have to come from overseas. Bank of America’s detractors give it another name: Bank in America. While a rival such as Citi now derives 50% of its revenues outside its home base, even the much more US-centric JPMorgan Chase has international revenues of about 25%.

Bank of America still earns 90% of its revenues from the US. That figure will rise in the short term with the acquisitions of US Trust and LaSalle, neither of which have international businesses to speak of.

It’s strange that a CEO such as Lewis, whose favourite saying is "there is beauty in diversity in all things", has a business so reliant on one market. And it seems to worry shareholders too, as Bank of America’s stock price has underperformed the S&P500 index for most of 2007. With many investors concerned about the US economy slipping into recession, exacerbated by the recent losses in the sub-prime market, which could spread to other areas of US consumer banking, is Lewis’s policy of riding the high-growth domestic wave about to come to a crashing halt?

It’s a charge that Lewis rejects. Of course there might be problems in the short term – he points to the conflicting signals in the US economy of rising food prices, high gasoline prices, slowing consumer spending and higher interest rates, balanced by low unemployment and good wage growth levels, as examples of why there is uncertainty. But he thinks it is a mistake to ignore the scale of the US market, and the level of diversity inherent in it.

Lewis is playing a long-term game, and is happy with his position. "I would say we’re not in a bad position over time if we are such a large player in such a large and diverse economy as the US," he says.

The global imperative

Lewis knows that in globalized markets where money flows across borders with little hindrance, a bank of BofA’s size cannot ignore the international markets.

Jonathan Moulds is London-based president of Bank of America’s businesses in Europe, the Middle East, Africa and Asia, and so at the forefront of the strategy. "Our clients are globalizing; we need to globalize with them, or we risk losing them," he says.

Bank of America is the top performer

Total annualized shareholder return 2000–2006

HOW LEWIS MAKES EPS MATTER

Growth in EPS, 2000–2006

Source: Bank of America


Another senior banker says: "Ken wants to be the CEO that takes Bank of America global. We are spread too thinly and it is a recipe for hiccups. If you look at Citi, they are important to a lot of people in a lot of places. We need to become important to more people."


That’s why many expect Lewis to make a transformational acquisition in Europe, Asia or on a global basis to get a foothold in other consumer banking markets. There’s much talk in London and beyond that Bank of America will seek to snap up Barclays if the UK bank fails to get ABN Amro. They might be sorely disappointed.

"There is no need for us to do an on-the-ground acquisition in Europe," says Lewis. "We’re not sure that everything that we do successfully in the US is transferable. Therefore we would need some margin for error in the price we paid, and at the moment European bank stocks are very fully valued. Plus there is the poison pill of the weakness of the US dollar."

Against that backdrop Lewis is going to stick to what he knows best. "We have no need for a major international acquisition when we have access to a huge and growing fee pool in the US where we can get 10% earnings per share growth just by playing to our strengths."

Lewis seems happy with his strategic stakes in Banco Itaú in Latin America, Santander Serfin in Mexico and China Construction Bank in China.

The Itaú stake is an interesting insight into Lewis’s approach. BofA inherited a limited banking network, which was part of the old BankBoston group, in Latin America as part of its acquisition of Fleet in 2004. The business, notably in Brazil but with small operations in Chile and Uruguay, did not fit Lewis’s criteria.

"We don’t like what I call ‘dangling participles’ – in other words, banks which have little chance of becoming a leading player and therefore cannot leverage their size and scale," Lewis says.

So Lewis struck a deal with Roberto Setubal, the CEO of Banco Itaú, whereby Itaú would take on the Latin American operations of BankBoston and, in return, BofA received a 7.44% stake in Itaú.

It looks like a canny investment. Itaú’s earnings per share rose 12.4% in 2006, and its market capitalization now stands at R$92.2 billion ($48 billion). Euromoney considers Itaú not just the best bank in Brazil but the best-run bank in the whole of Latin America.

But that doesn’t mean the market should expect further strategic, minority shareholdings. "We like to have a lot of dialogue back and forth. That takes a lot of time and work," says Lewis.

Lewis believes there are other and more efficient ways of accessing international consumer business through Bank of America’s existing platform. He points out that MBNA is already the largest credit card issuer in Europe, even though it is only presently available in the UK, Ireland and Spain. Plans to roll the service out into other European countries are advanced. The card charge doesn’t stop at Europe’s borders: BofA has just signed a joint venture agreement with CCB to sell cards in China. Lewis is also looking at ways to enter the Japanese credit card market.

The growth of internet banking is another potential avenue of growth for Bank of America. The bank has more than 50% of the online bill-paying market in the US. It sees some of these skills as being transferable to other markets. Lewis is certainly eyeing up the opportunities: he has noted the success of ING Direct in building top 10 market shares across Europe, and says that ING and its CEO, Michel Tilmant, are doing "a great job". One option under discussion is to launch a Bank of America Direct business in the UK.

Top five target in investment banking

The biggest challenge for BofA over the coming years is to become a player to be reckoned with in investment banking.

The firm’s track record in this area is far from stellar. Even its own senior management have in the past criticized the bank’s approach, one describing it a few years ago as "dilettante". Insiders and outsiders alike levelled the charge that Bank of America did not really care about investment banking. It played at the market, because its managers felt it had to be seen to do so while other banks with a US consumer foundation, such as Citi and JPMorgan Chase, added huge earnings through their investment banking operations.

Has anything changed? It appears so. Lewis and his board are putting their money where their mouth is. "We have spent $675 million building our US investment banking business, playing to our strengths, and using our great market shares and contacts. We have done this in little more than a year and still grown earnings in line with expectations," says Lewis.

It remains a reasoned rather than rushed approach. BofA will build from its strengths, and then build some more as the strengths of the investment banking franchise are established.

"We are not believers in the ‘build it and they will come’ mantra," says Lewis. "We need to be able to look our shareholders in the eye."

Bank of America already has excellent relationships with the corporate and financial institutions world. Its clients include 98% of the Fortune 500 companies in the US and 79% of the Global Fortune 500. These relationships, as well as a balance sheet that most banks would kill for, are the foundations for a lofty ambition.

"In time, we want to be one of the top five investment banks worldwide," says Lewis.

BofA’s US debt business is perhaps the template that Lewis would most like to follow. Bank of America is now ranked second in the US for both high-grade debt and for leveraged lending. It has a high-class CLO/CDO business. From there it’s an easier step to build more investment banking operations, such as M&A and even equities.

"We would not have been part of that deal two years ago. Now sponsors believe in us. They have plenty of other firms they can go to but they know we can provide products such as bridging equity and liquidity facilities a long way down the road"
J
onathan Moulds, Bank of America

Jonathan Moulds, Bank of America
Lewis describes leveraged finance as a "sweet spot" for Bank of America. Moulds points to the firm’s recent role in KKR’s buyout of Alliance Boots in the UK as an example of what BofA can achieve. "We would not have been part of that deal two years ago. Now sponsors believe in us. They have plenty of other firms they can go to but they know we can provide products such as bridging equity and liquidity facilities a long way down the road," says Moulds.


It’s a market the bank is committed to, despite some concerns expressed in public by Lewis about the potential for leverage to go too far. The bank’s CFO, Joe Price, says: "We have been involved in a lot of the largest private equity buyouts in the US over the past 12 months. We could not have done it without the well-capitalized balance sheet we have. It means we can make the investments we need to make to our client base."

There’s no better example of that than the private equity-led buyout of Sallie Mae in the US announced in April this year. An investor group led by JC Flowers bought Sallie Mae for $25 billion. BofA, alongside JPMorgan, advised on the takeover and contributed both short-term and long-term financing, and each took a 24.9% stake in the business. It is perhaps a deal showing the direction the bank wants to head in.

Building from debt foundations

The focus on building a debt business through bank relationships leads some Bank of America insiders to compare the bank’s strategy to that of Barclays Capital. But another analogy is pertinent as well. About 20 years ago, one Wall Street firm was looking to build an M&A franchise. It decided to focus its efforts on sectors in which it had the deepest knowledge and contacts. That firm was Bear Stearns. Today, says Lewis, one of BofA’s key strategies is to build first and fastest in the sectors the bank knows best, such as healthcare and real estate.

If Bank of America can combine the best traits of Bear Stearns and Barclays Capital, and leverage one of the biggest balance sheets in finance, then the rest of the market has much to fear.

However, most competitors’ knees are not trembling at the prospects of a surging BofA investment bank just yet. Indeed, most think that BofA will one day take the plunge and try to buy one of the bulge bracket Wall Street firms, such as Merrill Lynch, Morgan Stanley or Lehman Brothers.

Lewis says that of course he considers everything, but that this is not on the agenda. "The strategy is that we will build our investment banking organically, and that will remain the strategy... until it changes," says a banker close to Lewis.

Those who work for him would not rule anything out. "Look at Bank of America’s track record under Ken; he doesn’t sit around waiting for growth to happen in small increments. This is perhaps the most aggressive financial institution in the world," says a capital markets banker at the firm.

Much to prove in private banking

The acquisition of US Trust will make Bank of America, by its own reckoning, the largest private bank in the US. Of course private banking means different things to different customers, and to different wealth managers.

Bank of America wants to be a leading player across the wealth spectrum in the US: from the affluent customer with $100,000 of disposable assets to the ultra-high-net-worth family, in the $50 million-plus bracket.

It’s a bold ambition, and it’s clear that US Trust/BofA has a long way to go. In Euromoney’s 2007 private banking survey, neither outfit figured in the top 10 overall in North America. Bank of America squeezed into the top five for the super-affluent (assets of $500,000 to $1 million), and US Trust had a similar ranking for trust services.

That doesn’t deter Lewis. "The acquisition of US Trust is primarily aimed at gaining more market share in the $3 million-plus area, and especially in the $50 million-plus ultra-wealthy client. We’re already in that market; but US Trust makes us much better."

Beyond that, Lewis sees a clear opportunity among the middle-class rich in the US. "Our premier client banking group has enormous potential. We have millions of customers worth between $100,000 and $3 million already banking with us. Few of those are in our premier banking service."

Price expands on the scale of the opportunity: "We have 800,000 clients already in our premier banking service. We have a total of 7 million who qualify for it who already have an account with BofA. On top of that we have another 7 million potential premier banking clients through MBNA-style product."

The detail of retail success

While Bank of America tries to move to the next level in international markets and investment banking, it is determined to maintain its leadership position in its core market of US consumer banking.

Bank of America is used to competition. It grew up almost on the other side of the street to its perennial competitor Wachovia in Charlotte, North Carolina.

Joe Price, Bank of America

"We have 800,000 clients already in our premier banking service. We have a total of 7 million who qualify for it who already have an account with BofA. On top of that we have another 7 million potential premier banking clients through MBNA-style product"
Joe Price, Bank of America

But the bank’s position is constantly under pressure, from long-term rivals such as Citi and JPMorgan Chase as well as relative newcomers to the broader US banking market such as Wells Fargo. The latter has perhaps the deepest penetration of any client base in US banking – on average Wells Fargo sells 5.3 products to every consumer client and six to every commercial banking client. It aims to reach an average of 8 products per customer. Bank of America does not disclose similar numbers or targets.


Lewis is confident that his strategy is the right one to beat the competition. "Our sheer power, size and scale allows us to innovate in ways others cannot. Most banks say that they will use their size and scale to give back to shareholders. We say we will also give some back to the customer in order to grow our businesses and revenues in the longer term," he says.

Lewis points to a number of recent initiatives, which you’ll see marketed throughout the billboards and newspapers of the US. One is called "Keep the change". The premise is that when you buy something using your BofA card, the bank rounds up the purchase price to the next dollar and puts the difference into your savings account. Of course it helps that most retailers try to dupe the customer into thinking the cost of a good is cheaper than it actually is by pricing it just below the next unit price – for example $5.99 rather than $6.00.

 But it is the type of clever marketing that is a hallmark of Bank of America.

Other initiatives include introducing free online trading for clients with at least $25,000 in their accounts; and a no-fee mortgage that also guarantees the best possible rate to the client.

"We aim to increase our customer base and also our customer satisfaction ratings all the time," says Lewis. "We do that by having the right systems and processes in place, and also the right people."

Lewis says that on the retail side success depends on extreme attention to detail. "We monitor every day what each store’s sales are. And we make sure we have in place what our customers need. The Hispanic community in the US, for example, is very important to us. Half of our employees now speak Spanish." It’s no surprise, therefore, that BofA’s growth rates among Hispanic customers far exceed those in more established demographics.

And it’s not as if Bank of America has a full suite of products in the US. It is not a big player in the mortgage market, for example. Lewis says that Bank of America wants to be bigger in the direct consumer part of the business, but does want to be a wholesale mortgage provider. It’s one of the reasons he says he is unlikely to countenance buying one of the major mortgage companies such as Countrywide Financial.

Lewis will certainly be pleased that he had little or no direct exposure to the sub-prime market. So far, his track record looks impeccable. Now he needs to get the timing right on the next stage of BofA’s evolution. If he succeeds, competitors will perhaps make the progression from calling his firm Bank in America, to Bank of America, and settle on Bank from America. For a CEO that has achieved so much, the hard work is about to begin.