NEW YORK — Merrill Lynch & Co. swung to an unexpectedly deep loss in the third quarter on the back of a $7.9 billion writedown in its fixed-income trading business, a hit that exceeded the Wall Street giant's net earnings for all of 2006.
Merrill posted a net loss of $2.24 billion, or $2.82 a share, well beyond the damage the bank forecast in an Oct. 5 earnings warning. Then, Merrill said it could lose up to 50 cents a share after writing down $4.5 billion of subprime mortgages and collateralized debt obligations. The actual loss on those positions came in $3.4 billion higher after market values were re-examined and more conservative assumptions were applied in the intervening two and a half week, Merrill said.
The loss, Merrill's first since 2001, raises questions about the company's risk- management procedures and the board's confidence in Chairman and Chief Executive Stanley O'Neal, who along with his lieutenants has ratcheted up risk-taking in Merrill's fixed-income franchise in the past two years.
Mr. O'Neal, who was paid $51 million last year and rarely participates in earnings conference calls, will join the call Merrill is holding today at 10 a.m. EDT to discuss its results. (Listen in on the conference call).
The net loss compares with net income of $3.02 billion, or $3.17 a share. Revenue for the quarter cratered by 94% to $577 million. The bank earned $7.5 billion in all of 2006.
Merrill is Wall Street's leading underwriter of CDOs — bonds backed by other forms of debt including bonds, mortgages and loans — which continue to be under enormous stress.
In addition to its mortgage and CDO writedowns, Merrill recorded another $463 million of net losses, or $967 million before deducting fees, from commitments to finance leveraged buyouts and other corporate activities. The company said it exercised "aggressive and effective risk management" in limiting the corporate loan losses, unlike its inability to control continuing CDO losses.
Two-and-a-half weeks ago, Mr. O'Neal replaced the firm's head of fixed-income, Osman Semerci, and his chief lieutenant in the U.S. and also appointed Ed Moriarty as the firm's new chief risk officer. Mr. Moriarty had led the firm's global credit and commitments group that monitored its leveraged loan exposure. Mr. O'Neal also named commodities head David Sobotka to replace Mr. Semerci.
"We expect market conditions for subprime mortgage-related assets to continue to be uncertain, and we are working to resolve the remaining impact from our positions," Mr. O'Neal said in the release. "Away from the mortgage-related areas, we continue to believe that secular trends in the global economy are favorable and that our businesses can perform well, as they have all year."
In the third quarter, Merrill cut its exposure to CDO-related asset-backed securities by 53% to $15.2 billion from the end of the second quarter. U.S. subprime-related exposure was cut 35% during the quarter to $5.7 billion.
In a report Monday, Standard & Poor's Corp. expressed concern over the difficulties of evaluating how well investment and commercial banks are valuing their losses on mortgage-related loans that are awaiting securitizations or sale and on mortgage-backed securities in their inventories. Merrill said that the bulk of its CDO losses occurred on the highest-rated tranches of CDOs it was holding.
S&P, Moody's and Fitch Investors all revised their outlooks for Merrill Lynch's credit ratings to negative after its preliminary writedown announcement two-and-a-half weeks ago. On Wednesday, Merrill highlighted potential pressures on its liquidity.
"Based on current market conditions, Merrill Lynch's liquidity position is strong," the bank says in a statement that didn't appear in recent earnings releases. "Because the markets are unsettled, and market conditions that affect the company's liquidity may become more severe, the company is continuing to closely monitor its liquidity and is pursuing opportunities to preserve and enhance its liquidity and capital position."
Outside of the losses in its structured securities, mortgage and loan businesses, Merrill said its other business are prospering. Equity-market revenue climbed 4% to $1.58 billion, and investment-banking revenue increased 23% to $1.01 billion on merger-advisory growth. They are part of firm's global-markets and investment-banking, or GMI, division, which posted negative revenue of $2.98 billion and a pretax loss of $4.44 billion because of the fixed-income write-downs.
Revenue at Merrill's global wealth management business, which includes Wall Street's biggest brokerage network with 16,610 financial advisers and Merrill's BlackRock stake, jumped 29% to $3.54 billion as pretax earnings from continuing operations soared 70% to $953 million amid record fee-based revenue.
Merrill added a net 410 brokers to its force during the quarter. Pretax profit in the unit rose 70% and profit margin rose to 26.9% from 20.4% a year earlier. However, wealth management profit was down 3% from this year's second quarter, while pretax profit margin fell sequentially from 27.5% last quarter.
Merrill is the only one of Wall Street's five biggest investment banks to have posted a third-quarter net loss, though all were battered by the mortgage and credit crises. The credit-related losses are the biggest to be reported from any securities firm in the third quarter.
source: 24oct2007
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