July 30 (Bloomberg) -- Merrill Lynch & Co. gave up any potential gains on $30.6 billion of securities it sold this week while remaining ``on the hook'' for losses, Bank of America Corp. analysts said, revising their earlier positive view of the sale.

Merrill agreed to sell collateralized debt obligations to private-equity firm Lone Star Funds for about 22 cents on the dollar and to lend about 75 percent of the purchase price. Bank of America analysts, who said yesterday the sale ``suggests the endgame'' for banks' CDO risk, today wrote they had overstated the ``positive implications'' of the transaction.

A drop in the value of the CDOs by about a further 5 cents would wipe out the equity from Lone Star and ``leave Merrill back on the hook for the exposure,'' said the analysts, led by Jeffrey Rosenberg in New York. Lone Star bought ``the upside of the underlying subprime assets in the CDO pools'' while Merrill retained ``most of the downside,'' they wrote.

Merrill, the third-biggest U.S. securities firm, has written down or lost almost $52 billion mainly on mortgage-backed CDOs since the third quarter of last year. Financial firms worldwide have marked down or lost $474 billion since the start of the credit crunch.

Merrill yesterday raised $8.55 billion by selling new shares to cushion the loss on the asset disposal. The bank will have recourse only to the CDOs it sold should Lone Star fail to repay the loan, it said July 28.

5-Cent Call Option

Lone Star effectively ``purchased a call option on the value of the subprime assets backing the CDO'' for the $1.68 billion it paid from its own funds, or about 5 cents on the dollar, the Bank of America analysts wrote today. That is about the level indicated by the lowest-rated portions of the benchmark Markit ABX.HE BBB- indexes of mortgage-backed securities.

An option gives the holder the right and not the obligation to buy or sell a security at a stated price. A call option, which gives the right to buy, is a bet the price of a security will rise.

The Bank of America analysts wrote yesterday that the sale ``creates initial losses but relieves future uncertainty,'' before issuing its report today, titled ``On Second Thought?''

The cost of protecting Merrill against non-payment of its debt fell 15 basis points to 265, according to credit-default swap prices from CMA Datavision in London.

Credit Quality

Credit-default swaps, contracts conceived to protect bondholders against default, pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements. A decline indicates an increase in the perception of credit quality. A basis point on a credit-default swap contract protecting $10 million of debt from default for five years is equivalent to $1,000 a year.

Merrill rose as much as 7.6 percent to $28.25 in New York trading and was at $26.67 by 10:22 a.m.

Merrill's sale ``may set a benchmark that will be followed by other financials,'' BNP Paribas SA analysts wrote in a client note today, saying they ``do not believe that other banks'' have written off 75 percent of the value of their CDOs as Merrill has.

``As more firms follow, writedowns will inevitably occur,'' according to BNP.

Citigroup Inc., the biggest U.S. bank, will probably write down the value of CDOs by $8 billion in the third quarter, Deutsche Bank AG analyst Mike Mayo said yesterday. The company may be forced to raise more capital as a result, Mayo said.

CDOs repackage bonds, loans and credit-default swaps and use the income to pay investors.

Merrill spokeswoman Jessica Oppenheim in New York said the firm's policy is to decline to comment on analyst reports.

To contact the reporter on this story: John Glover in London at johnglover@bloomberg.net

Last Updated: July 30, 2008 10:50 EDT