Bank of America Merrill Lynch

I can still remember raising my eyebrows when I heard that Bank of America had agreed to take on Merrill Lynch. On one hand, Merrill had a very ugly balance sheet to deal with. On the other hand, Bank of America might be getting a premier investment bank for what seemed like pennies. In the long-term, once Merrill's toxic assets were gone, I thought the deal had potential to be extremely valuable, except for one problem: culture.

The Wall Street Journal reports today that the merger isn't going so well, at least from a talent retention perspective:

Merrill Lynch & Co. spent decades building one of Wall Street's premier investment banks. Undoing that work has taken just months.

Merrill has lost at least 18 veteran investment bankers since the firm agreed to sell itself to Bank of America Corp. in September, thinning its senior ranks

At an investment bank, talent is the commodity that matters. If that doesn't stick around, the bank becomes all but worthless. In other words, with each veteran Merrill banker that leaves Bank of America, the value of that acquisition declines. Oddly, the WSJ doesn't think that matters:

In a business where human capital is often a firm's most valuable asset, such an exodus can prove fatal. Yet for Bank of America, the Charlotte, N.C., bank with a $2.3 trillion balance sheet, the departures aren't likely to make much of a difference in the long run.

The reason: Merrill's investment-banking revenue is unlikely to amount to more than a fraction of the combined company's overall earnings. When Merrill was an independent firm, a business such as M&A counted as an important source of profit. For Bank of America, such fees are negligible.

Huh? Sure, Bank of America's focus in the past has been commercial banking. But the decision to acquire a premier investment bank should have signaled a shift in that strategy. Otherwise, what's the point? The departures make a huge difference in the long run, because the future value of the investment banking platform that they paid billions (and took on untold billions of liability) to acquire decreases.

So why are those bankers leaving? For the very reason that the WSJ gets confused: because Bank of America is chiefly a commercial bank, not an investment bank. Few banks have managed to be successful in both spheres. There are a couple notable exceptions including Citigroup (uh, prior to 2008) and JP Morgan Chase. The reason those banks have had successful investment banking arms had to do with culture.

Even though those banks had a large focus on commercial banking, they set their investment banking business as a priority. Even if the lion's share of JP Morgan's profits come from commercial banking, if you asked its CEO Jamie Dimon, whether investment banking revenues matter, he would stare at you like you've got three heads. Of course they matter.

But more importantly, these few banks were okay with the risk investment banking posed. That's why JP Morgan's acquisition of Bear Sterns will ultimately be a successful one. JP Morgan was already a major player in investment banking before the acquisition. It understood the risks involved in the business and embraced them.

Several years ago, before investment banking went haywire, Bank of America tried to organically develop a premier investment banking arm. In fact, Ken Lewis, the current Bank of America chief executive responsible for the Merrill acquisition, led the charge. They acquired new talent and entered new markets. But they just couldn't make it work. In October of 2007, having accepted that their venture into investment banking was a failure, Lewis famously proclaimed:

I've had all of the fun I can stand in investment banking at the moment.

But then they went ahead and acquired Merrill Lynch anyway a year later, because it was too good a deal to pass up. Unfortunately, the same problem persists. Bank of America's management doesn't understand the investment banking business and probably isn't crazy about the risks involved in playing ball.

At this point, it's likely already too late to reverse course in how it's treated the Merrill acquisition and attempt to shift its culture to accept investment banking with open arms. Of course, this economic environment wouldn't make that shift any easier.