Merrill sparks fears, bank crisis costs to soar

Merrill sparks fears, bank crisis costs to soar

Jul 30, 2008
Reuters

LONDON/NEW YORK - MERRILL Lynch's surprise write-down ratchets up pressure on rivals to cut the values of their own sub-prime assets as they grapple with mounting debts and economies weaken.

The global credit crisis, roughly a year under way, could cause total damage of around US$1 trillion (S$1.4 trillion) to balance sheets of financial services companies. That's far above the more than US$400 billion of write-downs taken so far.

Merrill's revelation of a US$5.7 billion write-down and plans to sell US$8.5 billion of stock heightened worry of more pain to come from European lenders UBS and Barclays, and from Wall Street and United States commercial banks.

Citigroup, Bank of America, Lehman Brothers Holdings and Wachovia, for example, each still have billions of dollars of exposure to complex debt, mortgages, or both.

About US$4.4 billion of the Merrill write-down came from a sale of US$30.6 billion of collateralised debt obligations - which are typically backed by mortgages - to private equity firm Lone Star Funds for US$6.7 billion, or 22 US cents on the dollar. Merrill had valued the CDOs at US$11.1 billion just four weeks ago.

'It was a very aggressive markdown,' said Mr Chris Henson, a portfolio manager at MFC Global Investment Management in Toronto. 'The question is, is that now the clearing price for anyone who has CDOs?'

Prospects of more write-offs and credit losses have already battered lenders' shares. The Standard & Poor's Financials Index, for example, had through Monday fallen 32 per cent this year, twice the S&P 500's decline.

'The current environment is not one where people are prepared to give the benefit of the doubt,' said Mr Gerry Rawcliffe, group credit officer for financial institutions at Fitch Ratings. 'There's a broad loss of confidence in banks.'

Merrill's sale may also offer insight into the value of rivals' so-called Level 2 and Level 3 assets. Banks value these based on prices of similar securities in the marketplace, or on their own models when there is no market for them.

'Other buyers out there are going to use this as a reference point,' said Mr Michael Hampden-Turner, a Citigroup credit strategist. 'The question is, to what extent does 22 cents constitute fair value, or the price at which a bank could offload a huge volume of very distressed assets?'

Tough to value

It remains difficult for outsiders to assess the quality of assets on balance sheets. Some banks, such as Barclays, claim their assets are better-quality and more well-hedged.

Citigroup said it ended June with US$22.5 billion of sub-prime exposure. That included US$18.1 billion of super-senior asset-backed securities CDOs (ABS CDOs), the kind of debt Merrill sold, including US$14.4 billion of commercial paper.

Deutsche Bank Securities analyst Mike Mayo said Citigroup might face an US$8 billion write-down on CDOs, as the bank has valued them at 53 US cents on the dollar. Fox-Pitt Kelton analyst David Trone estimated a US$4 billion write-down.

Citigroup spokesman Shannon Bell declined to comment. On July 18, Chief Financial Officer Gary Crittenden said: 'There has not been a single American dollar cash flow loss against the asset-backed commercial paper ... I rush to add that that is not a forecast for the future.'

According to Oppenheimer analyst Meredith Whitney, Lehman ended May with about US$600 million of gross ABS CDO exposure, and US$29.4 billion of commercial mortgage exposure.

Lehman spokesman Randy Whitestone declined to comment.

Bank of America said it ended June with US$8.43 billion of net CDO exposure, including US$5.17 billion of sub-prime debt it was carrying at 43 percent of its original net exposure.

'We price our CDOs frequently during the quarter,' spokesman Bob Stickler said. 'The values take into account everything, including underlying asset flows and external market events. We would certainly take the Merrill sale into account, but it wouldn't be a single driver of valuation.'

European lenders may also take hits. Mr Stuart Graham, a Merrill analyst in London, said that under his revised 'stress test', large banks on that continent may have US$58 billion of future write-downs, up from his prior US$22 billion assumption.

Harder to lend?

Falling asset values could also make lenders less able to lend or more skittish about extending credit.

'They become much more cautious,' Citigroup strategist Hampden-Turner said. 'If you are a homeowner, it is harder to refinance. If you are a company, you can't borrow money as before.'

Pacific Investment Management, where Chief Investment Officer Bill Gross runs the world's biggest bond mutual fund, last week estimated that global banks could face US$1 trillion in losses from the credit crisis and lowered asset prices.

Wachovia said it ended June with US$5.86 billion of sub-prime exposure, including US$4.38 billion of mostly hedged ABS CDOs. It also has a US$122 billion portfolio of adjustable-rate mortgages where many borrowers owe more than their homes are worth.

Spokesman Christy Phillips-Brown declined to discuss the exposures, but said the fourth-largest bank is reducing risk, after losing US$8.86 billion in the second quarter.

Wachovia has hired Goldman Sachs Group, a Wall Street bank that largely sidestepped the credit crisis, for advice on what to do with its loan portfolio. Mr Robert Steel, Wachovia's new chief executive, is also a Goldman alumnus. -- REUTERS