Oct. 24 (Bloomberg) -- Merrill Lynch & Co., the U.S. securities firm that pushed into subprime lending last year, will add about $2.5 billion of writedowns to the $5 billion it disclosed earlier this month, the New York Times reported.

Merrill said Oct. 5 that it will post the first quarterly loss in six years after cutting the value of mortgages, asset- backed securities and loans for leveraged buyouts by about $5 billion. Analysts were estimating that New York-based Merrill would report a third-quarter loss of 45 cents a share later today, according to a survey by Bloomberg.

``It sends a very poor message to the marketplace that Merrill doesn't have a good handle on their risk,'' 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.

Even before any additional writedowns, the charge is the biggest in Merrill's 93-year history and the first major setback in Chief Executive Officer Stanley O'Neal's five-year tenure. A $7.5 billion cost also would exceed Citigroup Inc.'s $6.5 billion, the biggest reported by a bank for the third quarter. Merrill's failure to meet its own projection shows how the 56-year-old O'Neal misjudged the severity of the decline in the credit markets since July, after late mortgage payments from borrowers with poor credit histories surged.

Jessica Oppenheim, a Merrill spokeswoman, declined to comment after business hours.

Slumping Stock

Shares of Merrill fell 0.9 percent to $66.53 in German trading today. The report of further charges helped push the dollar lower against the yen. Credit-default swaps on Merrill were at 89 basis points at the close of trading in New York yesterday. The contracts reached a record 98 basis points on Aug. 16., and rose from 42 basis points in the past two weeks, data compiled by Bloomberg show.

Standard & Poor's Ratings Services, Moody's Investors Service and Fitch Ratings changed their outlook on Merrill's credit to negative from stable on Oct. 5, with Moody's saying the writedown ``substantially exceeded'' its expectations.

Merrill's stock is the third worst in 2007 among securities firms 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. Merrill is down 28 percent in New York trading. Goldman Sachs Group Inc., the biggest securities firm by market value, has gained 12 percent. No. 2 Morgan Stanley is down 5.9 percent. All the companies are based in New York.

Worst of Big Five

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,'' Fitzpatrick said.

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.

Merrill's results suffered from a ``weak September operating environment'' and didn't include a ``relatively strong June that the other brokers enjoyed,'' Sanford C. Bernstein & Co. analyst Brad Hintz wrote in an Oct. 1 note.

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, which oversees more than $200 million.

Merrill said in an Oct. 5 statement that it had about $4.5 billion of losses related to mortgages and other securities known as collateralized debt obligations, or CDOs. The firm also had to write off $100 million related to First Franklin Financial Corp., a home-lending company that Merrill 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.

LBO Loans

The credit markets also forced Merrill to write down the value of leveraged buyout loans that the firm had to make after investors refused to finance them. Those devaluations totaled $463 million, after underwriting fees, according to the Oct. 5 statement.

``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.

To contact the reporter on this story: Bradley Keoun in New York at bkeoun@bloomberg.net.

Last Updated: October 24, 2007 06:19 EDT