Bank of America in investment banking u-turn

2007-11-1 16:43:39 Source: http://ft.com

There was a glorious understatement in Merrill Lynch's earnings call earlier this week that will surely resonate with Bank of America (NYSE:BAC) executives. Merrill's massive $8bn write down was, it turns out, "outside the parameters of our risk appetite". You don't say.

For BofA, a smaller but still painful hit in trading credit products is leading to a rethink of its investment banking business. What areas does it need to be in, and does it have the skills to succeed? The problem is that, when the markets are booming, the fees on offer in investment banking look too good to pass up. A BofA presentation at the start of the year highlighted the potential for growth in structured finance. More broadly it noted the $6bn revenue gap to its top rivals in debt capital markets.

There are some good reasons why a vast retail and commercial bank would want a serious investment banking presence. It has a big balance sheet advantage over smaller broker-dealers, who do not have access to low-cost deposit funding. Furthermore, straight lending to companies has become a commodity business. Muscling into the advisory side, especially for private equity clients, increases the return on bread and butter loans. Even as Wall Street counts the cost of the buy-out boom that has just ended, financial sponsor activity will not disappear. As BofA's third-quarter results showed, there were ways of avoiding the excesses in that party: BofA, for instance, was careful to minimise exposure to leveraged loans with few protections or covenants.

The problems really start to mount the further away banks get from their clients. BofA is justifiably confident about its ability to get retail banking customers to take out a BofA credit card. It did not have the right, it turns out, to be as confident about its credit products hedging.