(Update 1: Corrected total write-down number to account for off-balance sheet write-downs) The hits keep on coming for Merrill Lynch and Co., Inc. (MER), who reported Thursday morning that it had generated a net loss for the third straight quarter. The first quarter net loss amounted to $1.96 billion — that’s $2.19/share — and compared with earnings of $2.16 billion one year earlier; Bloomberg reported that analysts had been expecting a loss of $1.72 billion. Revenues fell 69 percent during the quarter as Merrill absorbed writedowns totalling approximately $9.7 billion — $4.5 billion of which was the result of CDO write-downs and losses on hedges with financial guarantors, Merrill said. The Wall Street firm will also cut roughly 3,000 jobs as it looks to reduce costs, largely in the capital markets side of its business. CEO John Thain chose accentuate the positives — growth in the firm’s wealth management operations and international footprint among them — in remarks made in the company’s statement to the press. “Despite this quarter’s loss, Merrill Lynch’s underlying businesses produced solid results in a difficult market environment,” he said. “The firm’s $82 billion excess liquidity pool has increased from year-end levels, and we remain well capitalized. In addition, our global franchise is positioned strongly for the future, and we continue to invest in key growth areas and regions.” Alt-A hits the bottom line, while subprime mortgage pain subsides Total mortgage-related write-downs hit $4.3 billion for the first quarter, Merrill said, compared to $4.7 billion one quarter earlier. Thanks to accounting regulations, less than 28 percent of the mortgage related write-downs in the first quarter of 2008 hit the company’s income statement; in the fourth quarter of 2007, more than 72 percent of its such write-downs hit Merrill Lynch’s income statement. Interestingly, Alt-A write-downs are now outpacing subprime write-downs — suggesting that while subprime mortgage-related losses remain significant, losses more generally tied to weakness in the overall mortgage market and a weakening economy are increasing. Merrill’s net write-downs on Alt-A mortgages and related securities totaled just over $2 billion in Q1, while subprime net write-downs totalled a little over $1 billion. Merrill wrote off roughly $1.1 billion tied to Alt-A mortgages in the fourth quarter, by way of comparison. CDOs and monolines prove problematic Merrill saw its U.S. ABS CDO exposure jump to $6.7 billion in Q1, up from $5.1 billion one quarter earlier as a steep reduction in hedges more than offset $1.5 billion in writedowns — in plain English, this means that the firm is seeing its attempts to limit downside exposure fail at a rate that’s actually greater than the large losses already being recorded. HW’s sources suggest this likely puts Merrill in the undesirable position of facing more write-offs in the quarters ahead. In particular, Merrill took a $3.0 billion hit on a credit valuation adjustment tied to recent ratings downgrades of various monoline bond insurers — Merrill, like many Wall Street firms, purchased credit default swaps from bond guarantors as protection for its CDO positions. The Wall Street bank said that it essentially was forced to write off some of its CDS contracts tied to one guarantor altogether, after deeming them “ineffective.” Moody’s Investors Service said that it had placed Merrill Lynch on review for a possible downgrade after the earnings report Thursday morning. The rating agency cited “continued deteriorating conditions in the mortgage market and the increased expected losses on MER’s portfolio of super-senior CDO’s and related guarantor hedges as measured in Moody’s stress tests.” “Management at Merrill Lynch is focusing on the right issues for the rating — liquidity, capital and de-risking the balance sheet, however the mortgage market is not cooperating,” said Peter Nerby, senior vice-president at Moody’s. Disclosure: The author held no positions in MER when this story was originally published. HW reporters and writers follow a strict disclosure policy, the first in the mortgage trade.
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