Merrill Lynched By Subprime

1.17.2008 forbes

Wall Street's pain parade continued this week, as Merrill Lynch reported $11.5 billion in additional write-downs for the fourth quarter. In the period, the investment bank recorded a loss of $9.8 billion, or $12.01 a share, versus a gain of $2.3 billion, or $2.41 a share, in the corresponding quarter last year.

That was far worse than analysts' expectations for a loss of $4.70 a share, on sales of $702.1 million.

The wide miss disappointed investors, pushing the stock down 4.3%, or $2.38, to $52.71, in pre-market trading. Calling the results "clearly unacceptable," newly minted Chief Executive John Thain said he was nevertheless encouraged by the company's recent steps to strengthen its cash position. "Over the last few weeks we have substantially strengthened the firm's liquidity and balance sheet," Thain said.

Over the last few months, Merrill Lynch (nyse: MER - news - people ), along with other firms on Wall Street, have been aggressively courting foreign, often state-controlled investment funds for cash infusions.

In January, Merrill raised $6.6 billion from the Kuwait Investment Authority, Japan's Mizuho Financial Group (nyse: MFG - news - people ), Korean Investment Corp., and other investors. The transaction is expected to be finalized within the next three weeks.

In December, Merrill also secured $6.2 billion in funding from Singapore's government-controlled Temasek Holdings and New York-based Davis Selected Advisors. (See: "Merrill's Merry Day" )

Earlier this week, Citigroup (nyse: C - news - people ) simultaneously annouced $18.1 billion in write-downs and a $12.5 billion in cash from a collection of foreign investors. (See: "Citigroup's Write-Down Disaster." )

As expected, Merrill Lynch's sore spot was its fixed income business, which reported a negative $15.2 billion in revenue for the quarter, largely due to write-downs on collateralized debt obligations and subprime mortgages. The company said the business environment became more challenging in November and December, which resulted in "in substantially reduced client flows and decreased trading opportunities."

The disappointing fourth quarter comes as Merrill Lynch struggles to find its footing, in the credit markets and within its own walls.

In October, Chief Executive Stanley O'Neal (nyse: SXE - news - people ) stepped down after shouldering the lion's share of the blame for the firm's failure to effectively manage risk. At the end of June, just as the subprime mortgage debacle began to unravel, the firm had $32 billion in exposure to collateralized debt obligations, a type of investment-grade security backed by assets like subprime mortgages.

Weeks before the investment bank's third-quarter earnings report, O'Neal tried to calm investors, predicting that the firm would likely face a 50 cent loss. When the actual numbers hit the wall, they were far worse. In the third quarter, the company had recorded more than $8 billion in write-downs and a loss of $2.85 a share. The large miss hastened the departure of O'Neal and paved the way for a new chief executive officer, John Thain, to take the reins in mid-November.

In O'Neal's aftermath, Thain, the former chief executive of NYSE Euronext (nyse: NYX - news - people ), is struggling to clean Merrill Lynch's house and expose all the ugly lumps now, while the markets still expect hefty write-downs. (See: "Investors Trust In Thain" )

The massive write-downs have continued to disappoint investors, but Merrill's exposure to risky collateralized debt obligations are at least narrowing. As of Dec. 31, the company's exposure to CDOs was $4.8 billion. For comparison, it recorded an exposure of $15.8 billion at the end of the third quarter. Its exposure to U.S. subprime and other residential mortgages also declined to $2.7 billion, at the end of the fourth quarter, versus an exposure of $5.7 billion, at the end of the third quarter.