MERRILL WOES COULD SPREAD- Writedowns could total $1-trillion

Janet Whitman, Financial Post
Published: Wednesday, July 30, 2008

NEW YORK - Merrill Lynch & Co.'s stunning fire sale of US$31-billion worth of risky home-loan assets for US22¢ on the dollar could burn other big banks by forcing them to take similar writedowns.

Beleaguered financial giants in the United States and Europe already have written off more than US$400-billion over the past year in soured bets tied to the mortgage market.

Some market observers believe the write-offs could top US$1-trillion as home prices continue to tumble and foreclosures escalate across the United States.

Sovereign-wealth funds from Asia and the Middle East and private-equity firms swooped in with capital infusions for many big banks during the winter when it appeared the worst of the housing meltdown was behind the market. But with many of those bets now under water, such investors might be reluctant to pour new capital in given the prospect of further troubles with so-called collateralized debt securities, or CDOs, which include bundles and bundles of now near-worthless home loans that were sold off to investors around the globe.

"It's impossible to get a handle on the value of these CDOs," Charles Geisst, a professor of finance at Manhattan College and author of several books on financial market crises, said. "It would seem that sources of new capital are going to rapidly dry up for the banks if the write-offs don't stop. The liquidity crisis is hitting at all levels -- and this could be the next one."

Mr. Geisst said it could take another couple of years before the banks have made enough writedowns.

"It's amazing when you think about the number of people pumping their chests and saying the worst of this is over way back in March and April," he added.

To help offset it's big write-off, Merrill raised US$8.55-billion yesterday by selling new shares for US$22.50 each --a 60% discount to where it's stock was trading at the beginning of the year.

After the ouster of Stan O'Neal over the bank's enormous exposure to the faltering mortgage market, Merrill's newly installed chief executive John Thain announced huge writedowns. Over the past several months, he repeatedly assured investors the bank's troubles were behind it. Then he shocked the market late on Monday by announcing Merrill would sell a huge portfolio of mortgage-related assets for US$7-billion --just months after saying the assets were worth US$31-billion.

The massive markdown could put pressure on CDO prices across the board, giving rival banks less incentive to hang on to impaired assets in hopes prices will recover.

"We see this as a part of the cleansing process," said Kenneth Worthington, an analyst with JPMorgan.

Merrill is believed to be among the banks with the greatest exposure to such securities.

Temasek Holdings Pte., the Singapore-owned sovereign-wealth fund that became Merrill's biggest investor when it acquired a US$5-billion stake in December, was savvy enough to secure some price protection against such troubles.

Merrill had promised that if it sold stock at a lower price within 12 months, the bank would compensate Temasek for the difference. The difference, which Temasek has agreed to plow back into Merrill, was US$2.5-billion.

"One of the reasons that large investment banks have gone to sovereign-wealth funds is because they are classic, long-term, buy-and-hold investors," said Douglas Rediker, a sovereign-fund expert at the New America Foundation, a research and advocacy organization. "That means they don't get spooked by short-term market volatility."

Still, some observers expect sovereign-wealth funds will be a lot more circumspect with further investments in the wake of Merrill's surprise write down.

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(See hardcopy for Photo Description)

JB Reed / Bloomberg News

HOW MERRIL'S PROBLEMS ADDED UP:

ANATOMY OF A FIRE SALE

US$30.6B

Value of collateralized debt obligations sold by Merrill Lynch.

US$6.7B

Amount for which Merrill Lynch sold CDOs, which worked out to US22¢ on the dollar.

US$8.5B

Amount Merrill Lynch raised from stock sale.

US$900M

Latest amount sovereign wealth fund Temasek Holdings invested in Merrill Lynch.

US$51.8B

Merrill Lynch's 12-month total subprime losses including yesterday's US$5.7B writedown.

US$472B

Global total of subprime losses for the world's 100 largest financial institutions since the subprime crisis began.

http://www.financialpost.com/story.html?id=688494