Publié par : crise2007 | octobre 30, 2007

O’Neal Writedown Erased 20% of Shareholder Equity

O’Neal Writedown Erased 20% of Shareholder Equity
By Sebastian Boyd

Oct. 30 (Bloomberg) — At Merrill Lynch & Co., a lot more was lost than the $2.24 billion, or $2.82 a share, former Chief Executive Officer Stan O’Neal said would be subtracted from the third quarter.

The real damage to shareholders came with Merrill’s $8.4 billion writedown. It is the biggest in the history of Wall Street and wiped out four quarters of growth in shareholders’ equity, according to Merrill’s published figures. The charge, mostly for collateralized debt obligations and subprime mortgages, left the New York-based company with $38.8 billion of assets minus liabilities.

Losing « 20 percent of shareholders’ equity in one fell swoop is a serious blow, » said Robert Willens, the accounting analyst at Lehman Brothers Holdings Inc. in New York. « It might take them two to three years to earn that capital back. »

The writedown, which has ruined O’Neal’s 21-year career at Merrill, is more than the world’s biggest brokerage earned before taxes from fixed-income sales and trading in the past three years, according to estimates by Sanford C. Bernstein & Co. The decline may weigh on Merrill shares, this year’s second- worst performer among the five biggest U.S. securities firms, because many investors use book value to price the stock.

The company named Alberto Cribiore today as interim non- executive chairman to replace 56-year-old O’Neal. Cribiore will chair a search committee to find a replacement. Ahmass Fakahany and Gregory Fleming will continue to be co-presidents.

Bigger Loss

Merrill posted record revenue of $32.7 billion last year as O’Neal pushed the firm to become the No. 1 underwriter of CDOs, bonds created by packaging other debt securities.

The firm’s return on equity from fixed-income trading more than doubled to 38 percent in the first quarter of 2006 from 15 percent a year earlier, said Brad Hintz, an analyst at Sanford C. Bernstein in New York, in a report sent to clients last week.

Merrill said on Oct. 24 its loss in the third quarter would be $2.24 billion, about six times more than O’Neal disclosed earlier in the month.

« What they lost is likely to be more than they made in the last two years in CDOs, » Hintz said. « You can’t put it all down to CDOs, but it’s not a bad estimate. »

Merrill estimates it had $38.8 billion of shareholders’ equity at the end of September, down from $42.2 billion in June. The firm cut its compensation bill for the quarter to $2 billion from $4.8 billion in the previous three months.

Trading Risk

The firm still has $15.2 billion of CDOs, less than half the amount it held at the end of June. Merrill may have to write down another $4 billion in the fourth quarter, said Meredith Whitney, a New York-based analyst at CIBC World Markets, in a note to clients last week.

A 25 percent drop in the value of the securities would lead to a 10 percent decline in book value, Hintz said.

Merrill fell 2.9 percent to $65.45 in New York trading as of 11:10 a.m. today. Merrill has declined 30 percent this year, falling as low as $60.90 on Oct. 25. Bear Stearns Cos. stock has also fallen 30 percent.

Over the last five years, Merrill shares have had an average price of 1.96 times book value, or assets minus liabilities, according to data compiled by Bloomberg. The shares now trade at 1.55 times book value, below the valuation of 2.88 for Goldman Sachs Group Inc. and 2.06 for Morgan Stanley, the two biggest securities firms by market value.

Interest Payment Cushion

The erosion of Merrill’s equity leaves it with less of a cushion for interest payments on debt. The probability of Merrill defaulting on debt within five years more than doubled since June 30, rising to 7 percent yesterday from 3 percent, according to credit-default swap traders. The likelihood of Goldman missing a payment didn’t change.

CDS contracts based on Merrill’s bonds and used to speculate on its ability to pay its debt rose 3 basis points to 87 basis points yesterday after earlier trading as high as 93 basis points, according to broker Phoenix Partners Group. 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.

Moody’s Investors Service, Standard & Poor’s and Fitch Ratings cut their ratings on Merrill debt after the writedown. Moody’s downgraded Merrill for the first time in 11 years, reducing its rating one level to A1 from Aa3, the fifth highest ranking. S&P and Fitch both lowered Merrill to an equivalent A+ from AA-.

Value at Risk

Merrill’s average value at risk, a measure of the amount it could lose in one day’s trading, rose to $50 million in 2006 from $35 million in 2005. O’Neal’s strategy of making bigger trading bets and investing in leveraged buyouts took full-year revenue in 2006 above the previous high set in 2000.

Former Merrill CEOs, including William Schreyer and Daniel Tully, pushed the firm past its roots in retail brokerage into investment banking from the 1970s through the early 1990s. By 1997, Merrill’s value at risk was $69 million.

That figure dropped as David Komansky, Merrill’s CEO from 1996 to 2002, expanded in brokerage and asset management, businesses that provide steady, but lower returns. In 1999, Merrill’s VAR fell to $19 million.

O’Neal bought First Franklin Corp., the subprime mortgage unit of National City Corp., at the end of last year and in April said the company had added staff and made record loans to home buyers with poor credit ratings, even as losses in the market deepened.

Merrill is a passive minority investor in Bloomberg LP, the parent company of Bloomberg News

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