Merrill Lynch Stuns Market With $7.9 Billion Writedown On Its Mortgage Backed Securities Portfolio


On Friday October 5, Merrill (MER) preannounced an estimated $4.5 billion writedown on its mortgage backed securities portfolio which would result in a loss of up to 50 cents per diluted share for the quarter (Oct 5 Press Release).

But when they reported finalized 3rd quarter earnings this morning, things came in much worse.  They increased the writedown on their mortgage backed securities portfolio by $3.4 billion to $7.9 billion.  This resulted in a $2.3 billion, $2.82 per diluted share, loss for the quarter (3Q Earnings Release).

To put that $7.9 billion writedown in perspective, consider that Merrill earned $7.3 billion for all of 2006, which was its best year in a long, long time (2006 Financial Statements).

Or, to look at it another way, their book value, which is the value of their assets minus their liabilities, for their common stock holders was $37.6 billion at the end of the 2nd quarter of this year (2007 10Qs).  This size writedown represents a huge hit to the value of their assets.

Merrill appears poised to take over the role of poster boy for mortgage securitization disasters from Bear Stearns.

Markets are selling off on the news, as well as profit taking in Amazon after its earnings report last night, led by financials and tech:

Dow: -1.15%

S&P: -1.50%

Nasdaq: -2.15%

S&P Financials (XLF): -2.11%

S&P Tech (XLK): -1.92%

UPDATE (Wed 10/24, 11:45am PST): I just listened to Merrill’s conference call from this morning and the main focus of analysts was how accurate the current $15.2 billion in exposure to mortgage backed securities is.

That exposure is down from $32.1 at the end of the 2nd quarter.  $8 billion in writedowns gets us to $24 billion. 

The other $9 billion was sold.  Analysts wanted to know if the actual securities were sold into the market or if hedges were bought to reduce exposure. 

CFO Jeff Edwards said “both” but refused to supply details about how much of each was involved.

After that, analysts wanted to know how the $15.2 billion valuation of the mortgage backed securities was determined

They wanted to know if those were actual prices Merrill could get if they tried to sell them into the market right now or if they were more dependent on Merrill’s own valuation models.  They wanted to know how that valuation would be effected by further downgrades of the securities from the ratings agencies.

The questions come down to if the exposure is really $15.2 billion and, whatever the actual exposure, how much more writedowns we might possibly see going forward.

Very interesting.

David Gaffen has provided a good review of the conference call here.  And the transcript should be up on Merrill’s site soon.

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