Merrill’s Fire Sale Might Leave A Lot Of Fingers Burned

Jul.29, 2008 in Market Outlook

Last Update: 7/29/2008 9:03:18 AM

By Andrew Dowell and Ed Welsch
Of DOW JONES NEWSWIRES

Merrill Lynch & Co.’s (MER) fire sale of toxic assets might burn some other
fingers on Wall Street.

In the world of complex and infrequently traded securities, the venerable
investment bank’s move Monday to offload $30.6 billion in securities to private
equity firm Lone Star Funds produced a rare data point: a market price. And that
market price was a low 22 cents on the dollar.

Securities like collateralized debt obligations are highly varied and difficult
to compare to one another. But analysts said Tuesday morning that banks like
Citigroup Inc. (C) and Barclays PLC (BCS) - some of them carrying the securities
at higher values than 22 cents on the dollar - will have trouble ignoring
Merrill’s price.

In addition, Merrill’s move to decisively dump troubled assets could put pressure
on banks like Lehman Brothers Holdings Inc. (LEH) and UBS AG (UBS) to bite the
bullet as well.

It’s also possible insurers like American International Group Inc. (AIG) could
have a harder time viewing the impairment of similar assets as temporary. All of
that means the write-downs plaguing Wall Street likely haven’t come to an end.

“While these are Merrill-specific deals, they do have the potential to create
marks and put pressure on some other companies to de-risk their balance sheets
and take their lumps in an effort to move forward,” UBS analyst Glenn Schorr said
in a note to clients Tuesday morning.

Shares in Merrill, Lehman Brothers, Citigroup and AIG all plunged Monday.
Merrill, Citigroup and AIG were lower in recent premarket trading. Lehman was
flat.

Merrill’s sale, announced after the market closed Monday, appeared to be the
biggest slug of troubled assets sold off in one shot and publicly disclosed by an
investment bank during the credit crisis. It also commanded a low price.

Hedge fund Citadel Investment Group paid around $800 million, or 27 cents on the
dollar, last year for $3 billion in assets sold by E*Trade Financial Corp.
(ETFC). In May, UBS sold $22 billion in mortgage-backed assets to BlackRock Inc.
(BLK) for $15 billion. BlackRock is also liquidating about $30 billion in Bear
Stearns assets for the Federal Reserve.

In addition to being large and public, Merrill’s sale wasn’t forced by a crisis.
As such, it will be hard to ignore.

“This is the first large-scale CDO transaction that is not a distressed sale,”
Citigroup analyst Prashant Bhatia said in a morning note. “Industry participants
will likely mark super-senior CDO assets with 2006 and 2007 vintage collateral
down to the 22-cent range.”

Deutsche Bank analyst Mike Mayo said Citigroup may have to write down $8 billion
on its portfolio of CDOs as a result and cut his earnings estimates for the bank.
Citigroup values its portfolio of the securities at 53 cents on the dollar, he
said. There are arguments for that position, but Mayo believes Merrill’s sale
will force Citigroup to revalue its own holdings sharply lower. Goldman Sachs
analyst William Tanona agreed. Citigroup wouldn’t comment.

UBS shares plunged in Europe on concern the bank will take Merrill’s approach and
sell off troubled assets at a loss that forces another round of capital raising,
even as the bank repeated its position that more capital isn’t needed.

“Although UBS has said it expects to break even in the second quarter, there is a
risk that their results announcement will also include plans to accelerate the
rate at which they sell off their subprime exposures and this could result in yet
another large write-off and a capital-raising exercise to compensate,” said Peter
Thorne, London-based analyst with independent brokerage Helvea.

U.K. banks Royal Bank of Scotland Group PLC (RBS) and Barclays also slid.
Analysts at BNP Paribas warned against automatically assuming every bank will
have to take Merrill-like hits, but said Merrill’s quick turnaround on the value
of its securities will raise questions about the accuracy of banks’ marks.

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