Putting the trash out
In what area do we get financial rewards for dumping our garbage? Why, in the heady world of capital markets finance, where the announcement that you’ve lost any specific number of billions of dollars is better than not admitting how many billions you’ve lost.
“Billions and billions and billions of losses.”
Sound topsy-turvy?
No, we’re always headed the right way
Welcome to Wall Street. As reported in the New York Times:
Since becoming chief executive of Merrill Lynch in 2002, E. Stanley O’Neal has been credited with making the investment bank leaner and more disciplined.
It’s all in perception and semantics.
There’s no ceiling on the floor of our projections
When you cut staff and profits rise, you’ve become leaner. When you cut staff and profits fall, you’ve eliminated risk controls.
But analysts raised questions yesterday about the extent of that discipline after Merrill announced that it would take its first loss since the end of the technology boom and would write down $5 billion primarily in its fixed-income sector:
That’s a lot of Dirksens, and quite a bit more than some people expected. As I wrote just a few days ago:
Will the banks have to mark their positions to bottom? Billions in earnings, and multi-billions in shareholder value, ride on the outcome.
Amounts firms may have to revise, in billions of dollars (firm, followed by their potential write-downs and their 2006 profit).
Goldman Sachs $3.1 $9.4
Lehman Brothers $2.8 $4.0
Morgan Stanley $1.7 $7.5
Merrill Lynch $0.7 $7.3
Bear Stearns $0.7 $2.1
That’s a lot of shekels … and a little bird tells me there may be lots more.
Big writeoffs coming in the fourth quarter!
Where did those losses come from?
subprime loans, complex debt instruments and leveraged, or risky, loans.
Subprime loans we’ve covered at length in this blog. Complex debt instruments are the residue of securitization, and I think the Times wrote carelessly in its last phrase. All loans represent leverage; I think they were trying to say that some loans are junior, or mezzanine pieces, and therefore vulnerable even when the senior loan is relatively safe.
Merrill said it expected to lose up to 50 cents a share for the quarter, compared with a profit of $3.17 a share, or $3 billion, for the quarter a year ago. The size of the write-down was second only to one for $5.9 billion taken by Citigroup, which is three and a half times the size of Merrill.
Perhaps they unwillingly marked to bottom.
“While market conditions were extremely difficult and the degree of sustained dislocation unprecedented,”
Translation: It’s not our fault, don’t blame current management.
“we are disappointed in our performance in structured finance and mortgages,” Mr. O’Neal said in a statement.
Translation: We understand you’re feeling upset right now. Why don’t you take a stress pill?
“We can do a better job of managing this risk, as we have done with other asset classes.”
Translation: We’ve put out all the trash now.
Two ratings agencies, Moody’s and Fitch, quickly downgraded Merrill’s long-term debt outlook to negative from stable. Moody’s said the write-down, which had been forecast at about $4 billion, exceeded expectations. “As a result, Moody’s assessment of the quality of risk management at Merrill Lynch has diminished.”
Translation: When another $1.5 billion turns up, we have to do something because somebody missed something.
I think I’ve got it covered
In its report, Fitch said that the size of the loss and this week’s departure of crucial fixed-income executives raised questions about whether Merrill had adequate risk controls in place.
Losing $5.5 billion for one’s own account does raise that question.
Yesterday’s warning was the latest among banks as they try to deal with the fallout from losses in the origination and packaging of subprime loans as well as lending to private equity firms.
UBS has announced a $3.4 billion write-down, and Deutsche Bank, $3.1 billion.
And Washington Mutual, the savings bank, warned that third-quarter income would decline 75 percent.
Now, see, Job, it’s gonna be a bad third quarter for you
More bad news is expected. Analysts at Sanford C. Bernstein & Company said yesterday that they expected JPMorgan Chase to write down about $2 billion, and the Bank of America Corporation about $1 billion.
Merrill, however, will be the first big bank to report a loss. Its closest rivals, including Goldman Sachs, Lehman Brothers and Bear Stearns, all made money. (All had the benefit of June, which was a strong month. Merrill does not include June in the quarter but does include September.)
“They lost more than others,” Mr. Bove said. “Merrill tended to focus its efforts in the highest-risk areas because that’s where the rate of return was the greatest.”
We really liked the appreciation part, but this part …
The write-down has caused some frustration among the bank’s army of financial advisers [regular brokers – Ed.], who feel they make money for the bank while the investment bankers make more and then take risks that lead to painful blow-ups.
“We’ve seen this before,” said one executive who was not authorized to speak to the media.
When the credit business hit a wall in July, Merrill got caught with commitments to lenders that it could not resell and complex debt instruments, called collateralized debt obligations, that deteriorated sharply in value.
See, that’s a feature of complex interdependent high-velocity capital markets. If somebody stops, everybody stops.
Can we please clear out the unsold inventory, please?
It wrote down $4.5 billion worth of subprime loans and collateralized debt obligations and $463 million, net of hedges, in commitments to fund loans.
Major writedowns, big problems, people getting laid off, ratings lowered. What do you think the market did?
“Hey, I’m the reader, you’re the blogger, you tell me!”
Investors reacted by pushing up the stock, relieved that Merrill had provided information about its problems and a belief that the worst was over.
Pushing up
Shares rose $1.89, to $76.67.
I once knew a corporate banker who believed that if he lost a certain amount of money on a given loan volume, by doubling his loan volume he would be back to breakeven.
There are known unknowns … at least I think there are
[Richard X. Bove, a financial services analyst at Punk, Ziegel & Company] questioned that reasoning. “These companies are not going to see their markets jump back immediately,” he said. “The theory that if the company writes off $2 billion it should see its stock price up $1 and if it writes off $6 billion the stock should jump $3 is not one I can embrace.”
The market did.
Only five point five? I’m so relieved!
A Merrill spokesman declined to comment.
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