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Merrill Lynch Posts Wide Loss,
Discloses Bigger Write-Downs
By KEVIN KINGSBURY
October 24, 2007 7:55 a.m.
Merrill Lynch & Co. swung to a wider-than-projected third-quarter net loss because of $7.9 billion in write-downs on collateralized debt obligations and subprime mortgages.

Merrill had warned earlier this month that it would post a net loss of up to 50 cents a share because of writing down $4.5 billion in collateralized debt obligations and subprime mortgages and recording a net $463 million on leveraged finance commitments.

But the CDO and subprime write-downs were much higher than that and even above that of some analysts who were projecting Merrill to record write-downs at or above $7 billion. CDOs are pools of debt instruments, such as bonds or loans, that are repackaged into different slices carrying various levels of risk, then sold to investors. The company previously noted it "significantly reduced" its exposure to those products during the quarter.

The investment bank reported a net loss of $2.24 billion, or $2.82 a share, compared with year-earlier net income of $3.05 billion, or a $3.17 share, which includes a $1.1 billion gain from merging its money-management operations with BlackRock Inc.

The period's results also included a $967 million, or $463 million including underwriting fees, of write-downs on loans related to leveraged buyouts. Merrill had said the write-downs were limited by "aggressive and effective risk management."

Chairman and Chief Executive Stan O'Neal said the company re-examined its remaining CDO positions "with more conservative assumptions," resulting in the write-down size soaring.

He added, "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. 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."

In the third quarter, Merrill cut its exposure to CDO-related asset-backed securities by 53% to $15.2 billion from the end of the second quarter. U.S. subprime-related exposure was cut 35% during the quarter to $5.7 billion.

Outside of the impacts for the investment bank's fixed income, currencies and commodities business, Merrill had projected revenue rising at least 20% in its equity-markets, investment-banking and wealth-management operations.

The firm's global-markets and investment-banking, or GMI, operations recorded negative revenue of $2.98 billion and a pretax loss of $4.44 billion because of the write-downs.

The weakness in Merrill's fixed-income business was highlighted with the ouster earlier this month of the company's global head of fixed income, Osman Semerci, as well as his deputy, Dale Lattanzio, co-head of fixed income for the Americas. The firm also showed the door to their former boss, Dow Kim, the former co-head of institutional securities.

Equity-market revenue climbed 4% to $1.58 billion and investment-banking revenue increased 23% to $1.01 billion on merger-advisory growth.

Revenue at Merrill's global wealth management business, which includes the company's retail brokerage and nearly 50% stake in investment manager BlackRock, jumped 29% to $3.54 billion as pretax earnings from continuing operations soared 70% to $953 million amid record fee-based revenue.

The write-downs follow those made in the latest quarter by Merrill's investment-banking peers in September. This month, the nation's largest retail banks also recorded billions of dollars in write-down and increased credit-loss reserves in part because of the summer credit crunch.

MORE ON EARNINGS

The result will be pressure on Mr. O'Neal, who ousted two top bond executives three weeks ago when the extent of the losses became apparent, to make further changes.

Among those whose roles in the losses are likely to come under greater scrutiny will be Co-President Ahmass L. Fakahany, who backed the appointment in mid-2006 of the bond-management team that generated the losses, and Chief Financial Officer Jeff Edwards, who played a role in oversight of the valuation and risk levels of the firm's holdings.

Mr. O'Neal's own job could be in jeopardy depending on the actions he takes to reassure Merrill's board, which met over the past weekend, that his understanding and management of the firm's risk levels has improved. At the end of July, with a midsummer credit crunch under way, he sent a memo to reassure Merrill employees that the firm's risk level was under control.
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