Merrill Lynch faces huge loss due to bad mortgage write-downs

Last time when I wrote about Merrill Lynch posting record losses in its 93 years of existence, I knew some more pain was left, what the results exceeded all imaginations. Merrill Lynch reported fourth quarter loss of 8.6 billion USD from continuing operations. This is huge considering the profits it earned in 2006 - $7.5 billion. Total write-downs for this year so far have been around $16.5 billion. The breakup of the write-downs is like:
$9.9 billion - collateralized debt obligations (CDO),
$1.6 billion - sub-prime mortgages
$3.1 billion - bond insurance
$0.9 billion - residential mortgages
$0.2 billion - real estate investment

This is the second biggest write-down so far. Earlier Citigroup has written-down more than 23 billion dollars and reported close to 10 billion dollar loss in fourth quarter. Both these firms have been on a look-out for capital raising since last quarter and have successfully raised billions of dollars. But with the sub-prime crisis not coming to end these investment banks are poised to have a very tough time ahead.

Merrill had earlier replaced Stan O' Neal from the chief executive position following the sub-prime crisis. The new CEO of Merrill, Mr John A. Thain, has a lot of responsibility in bringing back Merrill to its original status. According to a report on Merrill Lynch's website, Mr. Thain said:

"While the firm's earnings performance for the year is clearly unacceptable, over the last few weeks we have substantially strengthened the firm's liquidity and balance sheet,.. In addition, a great majority of Merrill Lynch's key businesses delivered record results in 2007, and as I look ahead to 2008, the firm is intensely focused on continuing this momentum and delivering growth and increased profitability for our shareholders and employees."

With the declaration of results on 17 January Merrill's stock price fell by more than 10% in a single day. The stock has been falling since 2007 from a highs of around 100 to current price of 49.45 per share.

US subprime crisis: Can 2 million homeowners be rescued?

About seven hundred thousand houses in US had to undergo foreclosure in 2005 and this year the figure is likely to double. Even more the size of the ARM which is expected to get reset in next eight months is about 600 billion and includes some 2 million houseowners.

The foreclosures and home-mortgage defaults are likely to cause more pain in US because a lot of mortgages will be having the expiry of the freedom period (interest only), and teaser rates (initial low rates). The payment on these mortagages may rise considerably and lead to higher defaults. According to Bank of America $362 billion ARM is up for reset its interest rates. But this is not the only reason. According to a report by Wall Street Journal many subprime loans went bad during their initial periods.

“…While many accounts portray resetting rates as the big factor behind the surge in home-loan defaults and foreclosures this year, that isn't quite the case. Many of the subprime mortgages that have driven up the default rate went bad in their first year or so, well before their interest rate had a chance to go higher...”

{Teaser rate is a reasonably low interest rate in the starting, which is increased after a set period, generally 2 years. An example of a teaser rate is a rate of 6.5% which rises to 9.5% after two years.}

Adding to the pain is the crash of housing market due to which the value of property has reduced drastically leaving many borrowers and house owners with a loan amount more than the value of their property.

How can the situation be controlled?

The situation is getting out-of-control by the time. Though Fed has reduced the interest rates, its effect is not significant. The country’s money supply is squeezing and dollar is degrading. Injecting more money supply into the system, lowering interest rates further may help solve the situation, but in the long run better regulatory measures are required to prevent or identify any kind of uncontrolled activities in the economy early to limit the damage. Big banks can recover from billions of write-offs in their balance sheet but what about a normal person who has lost all his/her life’s earnings including his house. It’s a very urgent matter and needs to be dealt with immediately to control the extent of damage.

How deep is Japan in subprime mess?

According to an estimate by Japan’s Financial Services Agency (FSA) Japanese financial institutions have lost over 230 billion ¥ (Yen) or about 2 billion dollars this fiscal half year because of degradation of the US sub-prime investments. This is about 17% of its total exposure of 1.3 trillion ¥ ($12 billion) in the securitized instruments as of September 2007.

Official estimate by the Japanese financial supervisors on the impact of US sub-prime crisis and came after the Japanese largest financial lender Mitsubishi UFJ Financial Group reported its half yearly results. FSA had surveyed 575 financial institutions in Japan primarily to gauge the extent of sub-prime related exposure and its impact of their performance. These included 10 major banking groups, 110 regional banks and a total of 455 cooperative financial institutions.

Out of the 1.3 trillion Yen exposure 1.2 trillion is to the top 10 banking groups. According to Nikkei, Japan's leading six banking groups are likely suffer a total loss in excess of 300 billion yen ($2.75 billion) due to bad debts originating from the slump in the U.S. housing market. Regional banks were less affected. They were hit by about 15 billion yen loss.

The six leading lending institutions of Japan are:

1. Mitsubishi UFJ Financial Group
2. Sumitomo Mitsui Financial Group
3. Mizuho Financial Group
4. Sumitomo Trust & Banking
5. Resona Holdings
6. Mitsui Trust Holdings

The above six banks have written-down 115 billion yen ($1.1 billion) as bad debt. All of these, including, the top three banks, which are also known as megabanks, have shown a decline in profit so far this year.

Mitsubishi UFJ Financial Group Inc., Japan's largest bank, has reported a loss of 260 billion yen in subprime mortgage related investments. The exposure of Mizuho, Japan's second-largest bank, is about 800 billion yen in the US mortgage-linked securities as of the end of September. 575 Japanese banks and credit unions held subprime-related products worth $1.2 billion in book value and recognized $985 million in unrealized valuation losses.

Yoshimi Watanabe, Minister of State for Financial Services and Administrative Reform, said at a briefing in Tokyo:

"In response to this market turbulence, we will pay due attention to the status of risk management by financial institutions and the conditions of financial markets from a wide range of standpoints, while cooperating with other authorities in Japan and abroad."

According to Seiji Nakamura, a policy board member of the Bank of Japan, :

"We need to watch closely if the subprime problem will affect the global economy and if there will be a spillover effect on the Japanese economy,"

Wachovia, Bank of America, J P Morgan Chase affected by subprime wave

Bank of America, second-biggest bank of US, has accepted that its fourth-quarter results may get affected because of chaos in the credits market. BofA had $12.8 billion in liquidity support for CDO at the end of September. $9.8 billion of these are subprime related and $2.4 billion are in CDO trading.

JPMorgan Chase, third-biggest bank of US, is likely to write down more of its mortgage holdings in the fourth quarter depending on market conditions. JPMorgan had more than $40 billion in leveraged loans and unfinanced commitments on September 30. In the third quarter, JPMorgan wrote down $1.3 billion on leveraged loans and $339 million on C.D.O.’s.

Wachovia, fourth-biggest bank of US, had declared a loss of about $1.1 billion in October on assets backed mortgages. Earlier, Wachovia had reported $1.3 billion losses and write-downs in the third quarter of 2007. Its fourth-quarter result will be hurt by uncertainty in the credit markets to the extent of about $1.7 billion. Wachovia had high involvement in CDO transactions last year.

Barclays Plc, third-largest bank of UK, is yet to declare its involvement in the sub-prime mortgage securities. It had suffered a $4 billion hit due to trading, defaults and write-downs of CDOs in the third quarter. Speculations are high on its write-downs in fourth quarter.

Fourth quarter is going to be very tough for these banks as the liquidity crunch is worsening. Moreover their other sources of revenue like investment banking fees and trading gains are also getting marginalized.

AIG and Morgan Stanley declare their mortgage write-downs

AIG declared an after tax write-down hitting its bottom line by $2.7 billion and for Morgan Stanley this figure was $2.5 billion.

Morgan Stanley, the second biggest US securities firm after Goldman Sachs, has reportedly written down $3.7 billion in the first two months of its fourth quarter. More than $40 billion dollars have been written down so far by major banks and this figure is expected to escalate to $70 billion.

American International Group (AIG), world's largest insurance agency, had reported a 27% decline in earnings to $3.09 billion against $4.22 billion in the same quarter last year. AIG has insured some players against their mortgage related risks.

GM posts record loss on deferred tax write-down

Yesterday General Motors (GM) posted its biggest ever quarterly loss- a whopping figure of $38.6 billion. Last year for the same period the profit was $497 million. Such a big loss was due to one time items and write-down of deferred tax liability. The tax charge written down at GM is the biggest so far for any firm. These can be attributed as cumulative losses of last three years. GM has written down these because of expected lower profits in near future.

Excluding these exceptional items the losses were to the tune of $1.6 billion. Its financing subsidiary, GMAC Financial Services, has suffered because of subprime mortgage. GM has 49% stake in GMAC and it had contribute to slightly half of it losses.

Morgan may follow Citi & Merrill in writedowns

According to Fox-Pitt Kelton analyst Morgan Stanley may have to writedown $6b in ABS, CDO, and other assets. Morgan Stanley is second largest securities firm of US followed by Merrill Lynch, which had already writtendown $8.4b in subprime mortgages. Goldman Sachs, the biggest securities firm of US, is an exception to the sub-prime crisis as it claimed to be short on CDOs during the advent of the crisis.

Over the past three days Morgan Stanley's shares have declined by more than 17%. CNBC had reported than Morgan Stanley may write down $3b in fourth quarter.

According to an estimate Morgan Stanley has an exposure of $22b in ABS and CDOs.

Merrill Lynch pays $161.5 million to Stan O'Neal

This is the fifth largest exit pay given by any company.
Exxon Mobil Corp.'s paid the highest exit package of $351 million to Lee Raymond in 2006.
More details at Bloomberg.

Sub-prime fallout on banks

Effect on third quarter results:

Citigroup
CEO Chuck Prince likely to resign
Net profit of $ 2.4b against profit of $5.5b in the same quarter last year

Bank of America (BofA)
Slashed 3,000 jobs
The company is also exiting the wholesale mortgage business.
Net profit of $ 3.7b against profit of $5.4b in the same quarter last year

Merrill Lynch
CEO Stanley O'Neal resigned from his post on Oct. 30
Net loss of $ 2.2b against profit of $3.1b in the same quarter last year

Deutsche Bank (biggest private German bank)
Third-quarter write-downs of €2.16 billion($3.17 billion)
Investment arm reported a pre-tax loss of €179m
Total earnings up y 31% at €1.62 billion(US$2.3 billion)

Bear Stearns
Co-president and COO Warren Spector had to exit because of two Bear Stearns hedge funds meltdown.
600 job cuts in mortgage and investment banking businesses.
New York-based Bear booked a $200 million loss in the third quarter related to the hedge funds. Quarterly net income in the period ending August 2007 dropped 61% to $171.3 million.
Revenue fell to $1.3 billion from $2.13 billion last year.

Lehman Brothers
Closed its subprime mortgage unit BNC Mortgage in August and cut down 1,200 jobs.
$700 million write-down in third-quarter
Third quarter results to be declared on November 8

Morgan Stanley
Cut 600 jobs, scaled down its residential mortgage business.
Income fell to $1.47 billion from $1.59 billion.

Wachovia
Net Income decreased to $1.7b from $1.9 billion Quarter on Quarter basis while it was $2.3 billion in previous quarter of this year.

UBS (biggest Swiss bank)
Third-quarter loss of 830 million Swiss francs ($712 million) vs. a profit of 2.2 billion

Credit Suisse (the second-biggest Swiss bank)
Write-downs of 2.2 billion Swiss francs in the third
decline in net income to $1.1 billion, down 31 percent from the previous quarter.

Countrywide
Loss of $1.2b in third quarter against profit of $0.6b previous year.
First Quarterly Loss in 25 Years

Goldman Sachs
Reportedly made money on subprime business due to short positions

Chuck Price, CEO of Citigroup, is expected to resign

Citigroup's CEO, Charles O. (Chuck) Prince III, is reported to be planning to step down as Citigroup’s chairman and chief executive. (Source: Wall Street Journal).

Citigroup, the world's largest banking organization, has reported its third quarter earnings plunge by 57% due to writing down of sub-prime mortgage. Citigroup has seen a hit of $2.2 billion due to mortgage-backed securities (MBS) and credit trading. Further write-downs are not ruled out. Citigroup’s shares have crash down by about a quarter of its value since it reported decline in earnings last month. Citigroup is no longer world’s biggest bank by market capitalization. China’s ICBC has overtaken Citigroup in the rankings.

Earlier this week CEO and chairman of Merrill Lynch, Stan O’Neal, had resigned following his company’s $7.9 billion write-down due to sub-prime crisis. Bear Stearns CEO James Cayne is also facing scrutiny criticism of his leadership.

Most US banks have taken colossal hits from risky mortgage securities in the third-quarter of 2007. Merrill Lynch topping the list with $7.9 billion write-downs; UBS is second with write-downs of $3.4 billion. Fourth-quarter results may also get battered by recession in the U.S. housing and mortgage markets. According to some analysts Citigroup may have to suffer another $4 billion of write-downs in the fourth quarter.

Merrill Lynch posts record losses in 93 years

The largest US brokerage Merrill Lynch had suffered worst quarter since its inception year 1914. The write-downs across CDOs and U.S. subprime mortgages were close to $7.9 billion. Earlier it had reported that this to be close to $4.5 billion. The net loss for the third quarter was $2.24 billion. Merrill's chief executive Stan O' Neal is under heavy pressure from board of directors over the handling of the crisis and is likely to resign.

This loss has made Merrill Lynch the biggest setback of the sub-prime crisis. Its losses were more than the combined losses of the rest of the US brokerage. Earlier Bear Stearns had to close two of its hedge funds and suffer $1.5 billion loss.

Merrill Lynch's reported a total net revenues of $577 million in the third quarter of 2007 which was down 94 percent from $9664 million in the second quarter of 2007 and $9833 million in the third quarter of 2006.

"Mortgage and leveraged finance-related write-downs in our FICC business depressed our financial performance for the quarter. In light of difficult credit markets and additional analysis by management during our quarter-end closing process, we re-examined our remaining CDO positions with more conservative assumptions. The result is a larger write-down of these assets than initially anticipated," said Stan O'Neal, chairman and chief executive officer. "We expect market conditions for subprime mortgage-related assets to continue to be uncertain and we are working to resolve the remaining impact from our positions," Mr. O'Neal continued. "Away from the mortgage-related areas, we continue to believe that secular trends in the global economy are favorable and that our businesses can perform well, as they have all year."

Source :Merrill Lynch Press Release