Ouch. After the close of trading July 17, Merrill Lynch (MER) posted a second-quarter loss of $4.7 billion, or $4.97 a share, on $9.4 billion in writedowns related to collateralized debt obligations and the firm's exposure to troubled bond insurers. The damage sustained by the Wall Street giant was greater than even the most pessimistic of analysts, Oppenheimer's (OPY) Meredith Whitney, expected and sent Merrill's stock reeling—it was down 6.2% in after-hours trading July 17.
Where did the writedowns come from? First came the CDOs, with Merrill having to eat $3.5 billion because of their lowered value. Then, Merrill had to set aside more cash to cover the downgrade in the credit ratings of the bond insurers—another $2.9 billion. Throw in losses of $1.7 billion in the investment portfolio of Merrill Lynch's U.S. banks and $1.3 billion from residential mortgage exposure and it adds up to another nightmarish quarter.
Still, Merrill investors can be happy about one thing: CEO John Thain kept his promise not to dilute their holdings by issuing more stock to raise new capital. Instead, as widely expected, Merrill sold its 20% stake in Bloomberg back to the media company for $4.43 billion, less than the $5 billion to $6 billion it had hoped for. It also entered into an agreement to sell its Financial Data Services unit for $3.5 billion, bringing the total capital raised to nearly $8 billion. "They certainly sold more than people anticipated," says Sanford C. Bernstein (AB) analyst Brad Hintz. "At least they haven't sold John Thain's furniture yet."
Race Against More Writedowns
The firm's core business held up better than some expected. Merrill's revenues from banking, trading, and wealth management, among other businesses, were down 21% in the second quarter compared with a year earlier. "[That's] impressive, in light of persisting difficult market conditions," Standard & Poor's (MHP) credit analyst Scott Sprinzen said in a press release. The company also reduced its risk exposure across the board and added $10 billion to its capital pool, bringing the total to $92 billion.
Now, it just may be a race against time—and a battered balance sheet. With Bloomberg and FDS sold off, only the core businesses remain and the ratings agencies have already said they would view any sale of Merrill's stake in investment manager BlackRock (BLK) as a reason for a likely downgrade. But Merrill will likely face more writedowns during the coming quarters as it restructures the company around its banking, trading, and wealth management businesses. And toxic CDOs remain on the books.
If Merrill is forced to raise more money, Thain may have to break his promise to investors and sell common stock. But even that's not a given. "Will anyone be willing to put equity in the firm at this valuation?" says Chris Whalen of Institutional Risk Analytics. "I don't know."