Friday, June 20, 2008

Merrill CEO may face new write-downs

Merrill CEO may face new write-downs

Jun 21, 2008

NEW YORK, US - FOR some time Merrill Lynch CEO John Thain has been stressing the brokerage does not need to take more write-downs or raise more capital, but his confidence may have been misplaced.

Merrill Lynch was rumoured to be close to issuing a profit warning on Friday and a day after Citigroup warned of substantial second quarter write-downs.

The talk was taken seriously by investors, who pushed the shares down 4.6 per cent on Friday on growing concern about the investment bank's exposure to complex debt securities and derivatives known as collateralised debt obligations (CDOs).

The Citigroup warning, which came in an investor conference call, had been based on similar concerns. If the fears with Merrill turn out to be justified, the bank may again have to raise capital, a move Mr Thain said was not necessary as recently as last week.

But investors have heard that from Mr Thain before. In April, he told the Nikkei newspaper Merrill had plenty of capital and did not need more. A few days later, he made similar comments during a trip to Japan. Two weeks later, Merrill raised US$2.55 billion (S$3.48 billion) from selling preferred securities.

'If someone tells me that they don't need to raise capital, that everything's OK, I am not quite believing them,' said Mr Jim Huguet, co-CEO of asset manager Great Companies.

Mr Thain has also given an inconsistent message on whether Merrill would raise money through the sale of another big asset, its 20 per cent stake in news and financial provider Bloomberg. In April, he said he had no plans to sell the stake, but earlier this month, he said he would consider such a move.

'The real challenge'
Merrill will likely also get hurt by having used bond insurer MBIA to reduce its risk from CDOs. MBIA was stripped of its top ratings late on Thursday, leaving Merrill with more credit risk than it expected.

That means both Merrill's toxic CDO assets and the trades it used to reduce the risk of those assets could hurt the bank this quarter and potentially push it to sell shares or assets to raise more capital, analysts said.

'That's the real challenge for Merrill,' said Mr Brad Hintz, analyst at Sanford Bernstein.

Because the positions are hard to sell, Merrill Lynch is likely to hold onto the positions for some time, Bernstein's Hintz said.

'Every quarter, we are going to have a tough time,' Mr Hintz said.

Merrill Lynch reports earnings next month and analysts said the news will not likely be all bad. It has a strong brokerage business, an area where Morgan Stanley posted strong results this week.

Merrill's investment in BlackRock likely also performed well. On average, analysts expect Merrill to post earnings of 20 cents a share before special items, according to Reuters Estimates.

But write-downs could still weigh on results and, if the charges are high enough, the company could find itself having to raise more capital, analysts and investors said.

Merrill has recorded more than US$30 billion of write-downs since the 2007 third quarter and has raised more than US$12 billion of capital.

Merrill shares fell nearly 5 per cent on the New York Stock Exchange on Friday to US$35.95. Merrill shares are down 60 per cent over the last year, while the Amex Securities Broker/Dealer index has fallen 38 per cent over the same period.

Merrill's CDO holdings are complex, which makes them hard to sell.

'You just can't reverse out of these positions,' said Mr David Dreman, founder of Dreman Value Management, which is short Merrill shares. -- REUTERS

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