Monday, January 28, 2008

Merrill Lynch - Schreyer's Role

Donald T. Regan, became C.E.O. in 1971. In 1975, the Government abolished fixed commissions on stock sales, sparking cut-throat competition in the brokerage business.

Regan fathered the Cash Management Account, or C.M.A., which combined the characteristics of a debit card, money market checking account and brokerage account.

He also led Merrill on its first major diversification drive. He envisioned the company as a ''three-legged stool'' supported by businesses in the securities, insurance and real estate industries. Merrill would offer customers one-stop shopping for all their financial needs, and relieve the company's dependence on the cyclical brokerage business.

To establish the investment banking division, Regan tapped Schreyer, who had run the Government securities business and the New York branches, a very visible post. The division, later to be Capital Markets, encompassed underwriting, mergers and acquisition services and institutional sales, trading and research; it did not achieve critical mass until 1978 when Merrill acquired the old-line investment banking firm of White, Weld & Company.

Cost control problem at Merrill Lynch

Retail brokerage commissions continued to provide the lion's share of Merrill's revenues, and the brokers' expansive outlook prevailed: As long as the commissions kept rolling in, financial controls could take a back seat.

In 1981, Roger E. Birk, who had come up through the operations side of the business, succeeded Regan, who became Secretary of the Treasury. Schreyer was named C.E.O. three years later. By that time, the costs of Merrill's expansion into real estate, capital markets and insurance had mounted dramatically.

Additional Training for Brokers

Don Regan had eased Merrill's brokers into the brave new world of financial services; Bill Schreyer accelerated the process. The time had passed when a broker could spend his day simply dispensing market wisdom (mostly provided by his research department) and booking buy-and-sell orders. Brokers were to be known as ''financial consultants,'' and they were expected to learn how to sell the new products, including life insurance and mutual funds, into which Schreyer was pouring Merrill's money.

The old-fashioned customer's man had trouble adapting to the asset-management strategy, and Merrill is still developing approaches to cope with this problem. The selling skills and knowledge a broker needs in daily contact with customers are very different from those called on to book a single order for a life insurance policy or to persuade a customer to set up a trust. The company has adjusted its hiring and training policies to develop a cadre of new-look brokers, and has dispatched 200 so-called ''specialists'' to the branches to help sell the non-securities products.

Merrill's target customer has at least $50,000 in household income. By the year 2000, with the baby boomers at their top earning capacity, the number of households above the $50,000 level is expected to double, as is the total of their assets. Something to shoot for, but will the asset-management strategy carry Merrill to its profit goals?

Scheyer's investment banking aim

One afternoon in 1979, while Donald Regan still held sway at Merrill, Bill Schreyer shared a Manhattan taxicab ride uptown with John C. Whitehead, then co-chairman of the management committee of Goldman, Sachs & Company, a powerhouse of investment banking. At one point, Schreyer recalls, Whitehead asked, ''Why don't you just be satisfied with being the largest co-manager of securities offerings?'' As Schreyer recalls, ''I said, 'First of all, that wouldn't be any fun. Second, that's not what we want to be.' ''

What Schreyer and Merrill wanted to be was No. 1. In the brokerage business, that argument had much to recommend it: Large number of brokers and larger volume generates more commission income. But the investment banking business was different. The richest margins went to firms that had long-standing relationships with the nation's major corporations. How could the giant broker break into the club now?

Merrill's answer: sheer financial muscle and experience. Says Tully. ''We did not have the school ties; we did not have 200 years of experience. We therefore had to show municipalities and governments and institutions around the world that we were a factor.''

From a standing start in 1976, Merrill has bolted to the top of the debt and stock underwriting tables, winning first place in 8 of the 11 underwriting categories tracked by IDD Information Services in 1988. It has been the No. 1 underwriter of all securities, worldwide, for two years in a row.

Underwriting is the traditional bread-and-butter of investment banking, and Merrill, with its massive distribution system, has an advantage. But competition has trimmed underwriting profits over the years, and the immediate prospects for richer margins are limited. When the volume of all stocks and bonds underwritten last year fell by 15 percent, fee revenues declined 21 percent.

Investment bankers also fought for a piece of what is potentially the most profitable corner of investment banking, mergers and acquisitions. Corporations traditionally give such plum advisory assignments to their trustedlongtime banking associates. But in the takeover frenzy of the past decade, many companies were willing to join hands with any trustworthy stranger who could rescue them - Merrill Lynch, for example.

Merrill became a pioneer in 1980's-style merchant banking, putting up its own capital to facilitate takeovers. These temporary ''bridge loans'' would eventually be replaced with junk bonds and other debt, also provided by Merrill. Sometimes the firm made equity investments as well. Merrill's huge capital base provided a potent competitive weapon. Merrill became a player in some of the largest and most lucrative leveraged buyouts, from the $4.23 billionBorg-Warner deal to the $25 billion RJR Nabisco bonanza. Investment banking revenues soared from $720 million in 1985 to $1.1 billion last year.

Early Relations with Buyout groups

The firm's strongest relationships are with financial engineers and buyout groups, such as Kohlberg, Kravis, Roberts & Company. Their activities have markedly dwindled of late. Teh Capital Markets group of Merrill Lynch still lacks the close ties to many C.E.O.'s of major corporations. Despite the lack of relationships, M. & A. business is being procured through own capital of ML.

Loss in trading in 1987

In 1987, a lapse in managerial control in the trading of mortgage-backed securities left Merrill with a $377 million loss, an event Schreyer once referred to as ''my Chernobyl.'' Howard A. Rubin, a senior trader whom Merrill had lured away from Salomon by tripling his salary, took a risky position with an exotic derivative of a mortgage-backed security. Initially, the firm knew about the position, and deemed it 'tolerable.' Then Rubin increased his bet, but failed to disclose the new position immediately.

When Rubin's action was learned, traders and salesmen started trying to unwind the firm's position discreetly by selling the securities to customers. But very quickly, a group of executives led by Jerry Kenney, head of the Capital Markets group, and Tully, took control of the situation. First they tried to hedge the firm's position, with little success. Then they began canvassing other dealers in the securities for possible buyers. Kenney called Alan C. Greenberg, the chairman of Bear Stearns & Company, who agreed to buy a big chunk at a bargain-basement price. Merrill dismissed Rubin;

London Market Push

Along with dozens of American investment bankers, Merrill wanted to be on hand in force for Big Bang - the deregulation of London's financial markets in October 1986. But few spent so grandly as Merrill. And when the foreigners began to suffer - because they were unfamiliar with the operations of the local markets and the intense competition - few hurt more than Merrill.

Merrill has now withdrawn completely from the European commercial paper and gilts markets, and cut its trading in European equities. In addition, the company has been consolidating its facilities in London and Zurich with a new strategy for London office. It is focusing on debt and equity underwriting and advisory work, particularly on so-called cross-border transactions - mergers and acquisitions, for example, that involve companies in different countries. Merrill wants to be ready for the economic integration of Europe in 1992.

Cost Control Efforts

During the six years since Bill Schreyer took over the reins, he has repeatedly talked of his determination to control costs. Yet total expenses, 92.3 percent of net revenues in 1985, actually increased to 94.6 percent for 1989 - excluding the special $470 million charge.

But Merrill is in fact taking a harder line on costs. Schreyer's Merristroika restructuring is basically a hard-nosed review of each business unit and its budget. The units are placed in one of three categories: 'special situations,' which need to be nurtured; 'core businesses' and 'burden of proof' businesses with poor returns. Merrill says that it can now confidently calculate each unit's return on equity which gives the ability to manage by analysis rather than by gut reaction.

Merrill has sold off a portion of Broadcort Capital Corporation, a securities clearance operation, thus trimming 300 employees from Merrill's books. Its Canadian brokerage operation, with 800 people, has also been sold. In fact, since 1987 Merrill has reduced its head count by 8,000.

Schreyer's focus on profitability, and his decision to subject his company to a $470 million writedown, are signs that Merrill may be changing. What remains to be seen is whether a man so shaped by the old culture can fully embrace the rigors of the new.

June 10, 1990

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