July 7, 2008 5:32PM

Why Merrill Lynch May Cut into Its Muscle

By Elizabeth MacDonald

Merrill Lynch has already laid off more than 5,200 people and raised about $15 bn as it struggles under massive writedowns never before seen in the history of this iconic Wall Street firm.

Some $4bn to $6 bn in more writedowns are expected when Merrill announces its latest results after the markets close on July 17. Expect an announcement of a capital raise in the form of an asset sale when its latest earnings are released.

But now chief executive John Thain must scramble to cut not just the fat marbled through an operation teetering under the weight of dangerously bad bets made by former chief executive Stan O’Neal and his coterie responsible for turning the Thundering Herd into the Blundering Herd.

Now Thain may have to cut into the muscle by unloading stakes in Bloomberg and BlackRock, moves he previewed when he spoke on a Deutsche Bank-sponsored investors’ call earlier this month. Thain said Merrill considered but rejected selling Merrill’s lucrative 20% stake in Bloomberg at the end of 2007, a sale in which Bloomberg has right of first refusal.

Merrill could get anywhere from $3 bn to $6 bn (unlikely) for this Bloomberg stake, and around $10.2 bn for its 49.8% stake in BlackRock (carried on the balance sheet at $8 bn), though insiders say this deal may involve just selling a portion of that position.

This is a backbreaking endeavor, but there is a reason why Merrill has to unload and can’t do an equity raise. Read through to the bottom to find out why. Merrill’s record write-downs have translated into losses of $14 bn, essentially vaporizing most of its profits earned in the three and a half years during the inflation of the housing bubble up until it popped last July.

Since Thain arrived in December, Merrill has scrambled to do capital raises to offset credit-related losses it has suffered in the last three quarters. What Merrill is enduring shows what all the financials are suffering through: Massive write-downs that have nearly wiped out the record profits they’ve earned during the housing bubble.

Merrill has $61.7 bn cash and equivalents on its balance sheet, it has $36.5 bn in shareholder equity, but it has $34.4 bn in illiquid level 3 trades, both assets and liabilities that it can’t get a pricetag on because no one wants these items. It’s got $9 bn in toxic subprime collateralized debt obligations, those cut and paste jobs few can make any sense of, with another $4.6 bn in asset-backed securities propped up by corporate bonds and loans. It’s got $44 bn in exposures to residential mortgages as well.

Thain can’t easily do a sale of common or preferred stock as Merrill has already due to price protections Merrill offered investors who bought more than $12.8 bn in common and preferred shares earlier this year.

The fine print of those deals require Merrill to compensate those investors in cash or stock if, within one year, the firm sells common stock, or securities convertible into it, at a lower price. Merrill’s damaged stock price would require an excruciatingly dilutive payout.

To be specific, Merrill Lynch sold last December$6.2 bn in common stock to Temasek, the huge sovereign wealth fund owned by the government of Singapore and also to Davis Selected Advisors. Separately, it also sold $6.6 bn in preferred stock in January to long-term investors via private placements, with the primary investors including Korea Investment Corp., Kuwait Investment Authority, and Mizuho Corporate Bank.

Both Temasek (not Davis) and the investors in the separate $6.6 bn capital raise wrung out of Merrill anti-dilution provisions that would force Merrill to compensate them in cash or common stock if additional common stock or convertibles were issued at a price below what they bought into.

For Temasek, that means any equity offering “under $48 per share within one year of the closing date of the deal,” says Oppenheimer’s Meredith Whitney, the leading Wall Street analyst, and now one of its most feared due to her correct calls on the financials.

Specifically, if Merrill sells any common stock or equity securities convertible into common stock within one year of the Temasek deal closing date at a price below $48, Merrill must make a cash or stock payment to Temasek for the difference of the $48 and the offering price of the new issuance, notes Whitney.

A $3 bn equity capital raise at $30 per share would be 18.8% dilutive to the downside. A $5 bn equity capital raise at $30 per share would be 22.5% dilutive, Whitney says.

7 Responses to “Why Merrill Lynch May Cut into Its Muscle”

Comment by Sean Baguley

July 8th, 2008 at 12:55 am

And, HSBC are waiting in the wings to see how cheap they can get in the game.
Comment by Greedom

July 9th, 2008 at 4:08 am

Isn’t it USB that just outranks HSBC in sub prime ? I recall USB having the highest.

Sheesh, just finding out what HSBC was acronym for- forget about exposing off balance sheet bad ideas !

I suppose not everyone has to play ball with a transparent eye feature only to US corps -

where I guess this new law promotes lower transparency as to who has the nastyburger loans - e.g. toxic waste.

I’m sure HSBC has their fair share, they’re up there.

USB I think beat them

orig. estimate iirc was about 60 billion for USB

who KNOWS what they’re up to at present limit wise.

Well gee though

if Frank and Jill can get a 500k mortgage in 2004 - no money down -no interest

and now ? it can be spread across 25 to 50 YEARS ?

with some initial knockdown on debt ?

bizarre

I suppose if that’s going out - might as well expect similar treatment for banks and investment banks.

of 7,000 banks - 1% is fair game on my list - this year.

just pretend a bank is a home owner - and FHA turns into direct pipeline account into oblivion at the treasury and hey -

either way

I want to know WHO bought a 500k home in 2004, no money down, 5 yrs + no interest

and NOW ? gets some WHAMMY figure knocked off the debt

ends up with an $720 a month payment spread over 35 years.

not to mention the home equity they maxed out of thin air too

to ALSO be remedied

in debt

hmm

Kuwait - TWICE cleared the debt of all its citizens.

I think the second time was the last time.

US can’t do that - but I do say - whoever bought these insane mortgages they KNEW in 5 yrs they’d be SLAMMED

win win - bizarre -

US corps too though win win

not so bizarre

Bernanke and Buffett both saying prevent failure of BS and prevent knockdown syndrome first.

I just wonder - how many other BS syndromes are out there ?
Comment by Greedom

July 9th, 2008 at 4:13 am

Frank and Jill to their neighbors

Frank and Jill were avid viewers of Fox News during the pilot run of the series Shock and Awe - in turn - bought into a 485k mortgage they never thought anyone would live through.

Today ?

Frank and Jill - having paid no money yet - no interest, Frank and Jill BOTH being unemployed- Frank daytrading on the extensions on home equity in the home - buying stock in the company that he ‘thinks’ has his deadbeat mortgage, which isn’t the right company.

yet ?

Soon - Frank and Jill KEEP their 1/2 Million dollar home -

pay only $600 - $700 a month
on an extended 50 year mortgage plan ?

ALL the debt for the black SUV Escalade to intimidate the neighbors ?

paid in full

and more

and it gets better !

They’ve lived 5 years - cost free !

utilities + school tax

Where was I on gravy train day at CountryWide

I should have taken out a mortgage I’d HAVE to believe the world was ending to do so !

in 2003
Comment by Greedom

July 9th, 2008 at 4:18 am

I still say

how is it the TWO top architects for the War on Terror, Media wise - Larry Di Rita - once under Rumsfeld to manage media on war on terror - now sr. spokesperson Bank of America

and General Tommy Franks - once - as Rush Limbaugh quotes it “He RAN the campaign on terror in Afghanistan AND in Iraq”

etc.

Gee - he’s now retired and on the Board of Directors for Bank of America

THE company that stands to win - potentially 1/3 a TRILLION USD bonus award -

for all those people that - I argue-
and conspiracy theorists take this as humor

one would HAVE to believe the world was ending to take on a mortgage like this

AND ?

to offer it ?

who in their right mind could offer this /

and pass on this toxic waste ?

“Oh, what’s that Frank and Linda ? you’re BOTH unemployed, well well - no problem !”

CW officer says

Ugh!

I say force loan originator to obligation, where top node fails, pass the responsibility to the next carrier of this diseased product - starting to reveal itself.
Comment by Greedom

July 9th, 2008 at 11:22 am

(might be report, browser never valided this was sent)
Ok Ok,

I’ll drop the Franks Di Rita war profiteering theory.

But from ML news above - 40+ billion in residential mortgage ?

from article:
$61.7 bn cash and equivalents on its balance sheet,
$36.5 bn in shareholder equity, but it has $34.4 bn in illiquid level 3 trades, both assets and liabilities that it can’t get a pricetag on because no one wants these items.
$9 bn in toxic subprime collateralized debt obligations, those cut and paste jobs few can make any sense of, with another
$4.6 bn in asset-backed securities propped up by corporate bonds and loans.
$44 bn in exposures to residential mortgages as well.

gee, 9 + 4.6 + a mystery bag of 44.

13.6 guaranteed problematic
call it 5 on residential to lowball it.

that’s 18.6 - NEARLY 1/3 total value of TOXIC WASTE !

Now, let’s presume stock holders figure that out - let’s call the 25 billion approx. in shareholders ? and devalue THAAAAAYAT 33% - at the least.

I’d say Merril Lynch isn’t cutting into its muscle.

I’d say Merrill Lynch will be lucky to not have to cut off a limb here.

Thanks for another article - you clearly have a strong grasp on the sector- I very much enjoy when people have forest from the trees insights or in your case, they read like detective stories at times, as the thesis reveals itself.
Comment by Greedom

July 9th, 2008 at 1:16 pm

I guess I’m saying, don’t forget to build 33% out of, or into - depending on how you look at it - your evaluation of ML. Too many L’s anyway.

R’s and L’s are extremely costly phonetically.

And Merrill Lynch has em.

Well, while THAT might be absurd - I see in ink -
the 9 billion in toxic subprime CDO’s.
take the 36.5 billion and keep in mind the impact of the 9 it will have on revaluing or reevaluating that 36.5 current stock pricing. I say - why not expect at least approx 33% down on the stock ?

so, another 12 billion loss OR what - stock at 24 billion - on a not so dry wafer called the dollar - and what restaurant serves soggy wafers eh ? (voice of Ukrainian farm woman age in her 90’s poking a stick as she yells it at you).

the loss just piles up

so, hmm- 30 billion pounds in Sterling ? Why, that’s probably nothing compared to what’s pushed out of London a day eh ?

ML could probably live and die on an over leveraged reach out of its boat on this stormy sea - tipping itself.

compared to what again - goes out of London probably for or through ML.

Sheesh, there’s an analogy here to one way a corporation can get consumed and deconstructed or just vaporized like Bear Stearns in a 48 hour window, or did BS really fall between Palm Springs CEO Schwartz saying “Ya know, I’ll tell ya, it’s ALL speculators involved here” and when it fell ?

something along those lines - but was it really that Friday eve when he said that to what ? Saturday ? MORNING ? EVENING ? I do wonder. Certainly by Sunday - Bernanke was off to sort out this 30 billion deal - regardless… I wonder was it Saturday technically- or better- what if it was Friday evening LATER - before midnight !

Then you’d have the CEO saying that on the same day -would be priceless.

oh well - I a new temp agency to offer short term insurance !

the new not so bad federalized American Expresses to any investment firm in trouble -

someone should just port out Bank in a Box and sell it to all investment banks - so they can claim they have one formal teller service - online only ! heh - and are qualified. - oh wait - SILLY ME - you don’t HAVE to be a consumer/commercial bank anymore - you can be a Bear Stearns and get that window served breakfast with a tab you can pay off later.

I still say oil is downstream from dollar - more importantly - I hear someone has taken the time to embed the solar I wanted - and now ? it’s a matter of a flat out $ investment - before I can finally benefit in charging my car while I roam a supermarket examining every product for 3 hours !

Don’t forget to look at the sub-pristine banks that came out golden in all of this subprime mess- Who knows, long term ? I bet Berkshire Hathaway swoops down and becomes a respectable insurance broker at the same time - as I once saw someone put it ‘minting’ it’s own money. heh Gee, that was 2 years ago, I can’t imagine the bargains out there for those with deep enough pockets to really restructure during all of this - picking up excellent buys.

Clarity in understanding what more primal causal factors drive the dollar for example has an excellent return rate ! no money down !

Oh well- would be a LOT of fun to see some of the top craziest loans offered from 2003 to the present.

In a way - call it celebrating their 5th birthday - where payments actually start showing up-

OR

do they ? ouch !

and I think that’s a serious question on the do they part.
Comment by Bank-Implode! » Merrill Lynch - $37.5B/*/$34.4B

July 11th, 2008 at 9:04 pm

[...] Merrill Lynch has almost no shareholder equity. The company’s shareholder equity has been almost entirely contaminated by Level 3 toxic trash. [...]