Merrill Lynch Reports Loss on $8.4 Billion Writedown (Update4)

By Bradley Keoun

Oct. 24 (Bloomberg) -- Merrill Lynch & Co. reported the biggest quarterly loss in its 93-year history after $8.4 billion of writedowns, the most by any securities firm.

The third-quarter loss of $2.24 billion, or $2.82 a share, was about six times higher than the New York-based company estimated on Oct. 5. Merrill wrote down the value of subprime mortgages, asset-backed bonds and loans to finance leveraged buyouts, and Chief Executive Officer Stanley O'Neal said in a statement today that he is ``working to resolve the remaining impact from our positions.''

Merrill fell as much as 3.1 percent in New York trading and now ranks as this year's worst performer among the five largest investment banks, after O'Neal misjudged the severity of the decline in the credit markets since July. Investors who lauded the 56-year-old CEO for chasing higher returns now question his management as the firm became the biggest underwriter of debt securities backed by subprime loans.

``We're very disappointed,'' said Rose Grant, who helps manage about $2 billion at Eastern Investment Advisors in Boston, including Merrill shares. ``I don't think Stan O'Neal will step down, but you do have to look at top management and wonder why they didn't know the extent of this loss.''

Third-quarter revenue fell 94 percent to $577 million, as losses in Merrill's fixed-income division overshadowed gains from underwriting stocks and providing merger advice. At Merrill's retail brokerage, the nation's biggest with a network of 16,610 financial advisers who cater to individual investors, revenue climbed 23 percent to $3.27 billion.

Compensation Drops

Merrill's compensation costs fell by 49 percent from a year earlier to $1.99 billion, indicating that the quarter's losses may reduce year-end bonuses for some of Merrill's 64,200 employees. The firm said today that it ``remains focused on paying its best performing employees competitively.''

Merrill said its holdings of so-called collateralized debt obligations, or CDOs, along with other securities and loans linked to subprime mortgages, lost $7.9 billion of their value in the quarter. CDOs are bonds created from pools of debt securities and loans.

The size of the writedown increased from $5 billion after Merrill conducted ``additional analysis'' since the firm's Oct. 5 announcement, O'Neal said in the statement.

``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,'' he said.

Unprecedented Loss

Merrill also wrote down the value of leveraged buyout loans the firm couldn't sell to investors by $463 million, after underwriting fees.

``It's safe to say this is the largest writedown'' by a U.S. securities firm, said Charles Geisst, a finance professor at Manhattan College in Riverdale, New York, and author of ``100 Years of Wall Street.'' ``The only other time we had such big losses was the third-world debt crisis in the 1980s. Even then, the losses didn't match this one.''

Merrill's writedown exceeded Citigroup Inc.'s $6.5 billion and increased the total third-quarter cost reported by the five biggest U.S. securities firms and five largest banks for bad loans and trading losses to more than $24 billion.

Slumping credit markets have led to the dismissals of industry executives including UBS AG Chief Executive Officer Peter Wuffli and Bear Stearns Cos. Co-President Warren Spector, and resulted in Lehman Brothers Holdings Inc., E*Trade Financial Corp., Citigroup and Merrill losing more than 20 percent of their stock market value.

CDO Inventory

Merrill said it reduced its inventory of CDOs comprised of asset-backed securities by 53 percent during the quarter to $15.2 billion. The firm also whittled down the size of its LBO loan commitments to $31 billion, 42 percent less than at the end of the second quarter. Short-term borrowings climbed 80 percent from the second quarter and shareholders' equity declined 9.6 percent.

The company dropped $3.30, or 4.9 percent, to $63.82 at 10:57 a.m. in New York Stock Exchange composite trading.

The stock was the third-worst among securities firms this year through yesterday, after E*Trade Financial Corp., which had home-loan losses at its online bank, and Bear Stearns Cos., where two hedge funds lost $1.6 billion of clients' money.

Goldman Sachs Group Inc., the biggest securities firm by market value, had gained 12 percent. No. 2 Morgan Stanley was down 5.9 percent. All the companies are based in New York.

Investors Flee

Merrill, the third-biggest securities firm, is the only one of Wall Street's five largest to report a loss from the credit contraction. Investor flight from subprime mortgage bonds and related debt left the company with inventories of loans and securities that had to be written down to depressed market prices.

``If you can't guide toward a reasonable expectation over two weeks, clearly you've got bigger problems,'' said William Fitzpatrick, a financial-services analyst at Johnson Asset Management in Racine, Wisconsin, which oversees $1.7 billion and doesn't own Merrill shares.

Goldman reported a 79 percent increase in profit for the three months ended Aug. 31 after betting on a drop in prices of securities tied to home loans. Morgan Stanley said profit from operations fell 7 percent in the quarter.

Earlier this month, Merrill fired Osman Semerci, the head of its fixed-income trading division, as well as Dale Lattanzio, one of Semerci's top U.S. deputies. Merrill also severed ties with Dow Kim, its former co-head of trading and investment-banking, who oversaw fixed-income trading until May, when he left to start his own hedge fund.

`Serious Embarrassment'

``This is a serious embarrassment for O'Neal,'' said James Ellman, president of San Francisco-based Seacliff Capital in San Francisco, which oversees more than $200 million.

Merrill said in an Oct. 5 statement that it also had to write off $100 million related to First Franklin Financial Corp., a home-lending company that it bought for $1.3 billion on Dec. 30.

Investors' refusal to finance mortgages with a high risk of default has made subprime lending unprofitable, forcing more than 110 companies to close, file for bankruptcy or put themselves up for sale since the beginning of 2006. Current and former clients of San Jose, California-based First Franklin say the unit is now barely taking loan applications.

``We've got more skeletons to find out about, because the credit cycle has yet to play out,'' said Jon Fisher, who helps oversee $22 billion at Fifth Third Asset Management and doesn't own Merrill shares. ``This isn't over in just a year.''

Merrill is a passive minority investor in Bloomberg LP, the parent of Bloomberg News.