Merrill CEO Thinks Worst Is Over For Subprime Woes - For Now

Source : The Straits Times, Jan 18, 2008

NEW YORK - JOHN Thain, presiding over his first set of earnings as the new leader of Merrill Lynch & Co, cleared the decks with some US$15 billion (S$21.6 billion) of subprime mortgage related write-downs that led to the largest quarterly loss since the the world's largest brokerage was founded 94 years ago.

And, while it was among the most aggressive moves on Wall Street to deal with bad bets on subprime mortgages, Mr Thain is still not ready to say the worst of the credit crisis is over.

With a possible recession looming, Merrill Lynch and other Wall Street investment houses might still be saddled with unforeseen turmoil. While taking steps to minimize future disruptions, Mr Thain is still wary about challenges that face the global financial markets.

'We will continue to take risks - you don't make money if you don't take risk,' Mr Thain said.

'But the risk will be sized appropriate for the business. Nobody should be taking risks that wipe out the entire annual earnings of a business, and certainly not the entire firm.'

That's exactly what happened under former CEO Stan O'Neal, whose heavy bets in subprime mortgage securities backfired as homeowners defaulted on their loans at an alarming rate. That strategy led to a nearly US$10 billion loss during the fourth quarter, on top of US$2.31 billion during the previous period.

Merrill Lynch posted a net loss after preferred dividends of US$9.91 billion, or US$12.01 per share, compared to a profit of US$2.3 billion, or US$2.41 per share, a year earlier. It also recorded negative revenue of US$8.19 billion, down from revenue of US$8.39 billion a year earlier.

The New York-based brokerage marked down US$11.5 billion from mortgage-backed securities, and an additional US$3.1 billion in adjustments to hedge positions on them.

Exposure to risky collateralized debt obligations, or CDOs, was US$4.8 billion at the end of 2007, down from US$15.8 billion three months earlier.

For the same periods, exposure to subprime-residential mortgages fell to US$2.71 billion from US$5.66 billion.

The huge housing-driven shortfalls come as weak economic data have intensified fears of a recession, and have increased pressure on the government for an economic stimulus plan.

There is growing evidence that the late payments and defaults that torpedoed the mortgage industry might be bleeding into other parts of the economy. Consumers are falling behind on all kinds of loan payments - like automobiles, credit cards and home-equity lines - that could tip the economy's scale toward recession.

Merrill Lynch joins rival Wall Street investment houses Morgan Stanley and Bear Stearns Cos. in posting losses in the last three months of fiscal 2007.

Citigroup Inc., the nation's largest bank, reported on Tuesday a quarterly loss of almost US$10 billion, the largest in its 196-year history.

'We believe risky assets (at Merrill) were conservatively marked, the exposures are still significant, and further deterioration in pricing so far in January means write-downs may not be over,' said Mr Roger Freeman, an analyst with Lehman Brothers, in a note to clients.


Problems will be identified

Mr Thain, who was CEO of NYSE Euronext and a former Goldman Sachs Group Inc president, said he's taking steps to help identify where the problems are. He brought in a new co-head of risk management, who was a former Goldman executive, and is also bringing in a senior executive to oversee all trading to get better control over the business.

He's also pledged to clear the brokerage's books and shore up its capital base to better position it amid the credit market turmoil.

Merrill Lynch secured almost US$13 billion worth of fresh capital, mostly from foreign wealth funds in Singapore, Korea, and Kuwait.

It also addressed the balance-sheet woes by selling a commercial-finance unit, and could make more divestitures in future quarters.

The brokerage also plans to move some trading assets into funds that will be sold to outside investors - essentially removing them from the company's books. Merrill is raising money for a real-estate fund in the Pacific Rim and hopes to create some private equity, and possibly infrastructure, funds.

Merrill Lynch shares tumbled US$5.64, or 10.2 per cent, to US$49.45 on Thursday when Wall Street tumbled after a regional Federal Reserve report showed a sharp decline in manufacturing activity and as investors feared that downgrades of key bond insurers could trigger further trouble with souring debt.

Merrill's shares have fallen almost 50 per cent since their high of US$98.68 last year, wiping out some $40 billion in shareholder value along the way. -- AP