Merrill Lynch: Unafraid of Contradictions

Aug. 5.08 | About: Merrill Lynch (MER)

God bless John Thain.

I’ve often wondered what exactly Merrill Lynch’s CEO was getting at. He routinely denies that Merrill (MER) needs to raise capital ... only to go and raise capital a few weeks later. For those of you who have lost track of Mr Thain’s assertions of the last year, we’ll do a quick recap:

  • 12/25/2007 "One of my first priorities at Merrill Lynch was to strengthen the firm's balance sheet, and today we have made great progress towards that by bolstering our capital position through these investments and our announced sale of Merrill Lynch Capital." (said the same day that Merrill raised $6.2 billion in capital)
  • 1/15/2008 “These transactions make certain that Merrill is well-capitalized” (said the same day that Merrill raised $6.6 billion in capital)
  • 1/18/2008 “We are very confident that we have the capital base now that we need to go forward in 2008”
  • 1/25/2008 “I don’t think we are struggling… we are very well positioned to go forward into 2008.”
  • 2/24/2008 Merrill raises nearly $600 million in capital.
  • 3/16/2008 “We have more capital than we need, so we can say to the market that we don’t need more injections.”
  • 3/18/2008 “Today I can say that we will not need additional funds.”
  • 4/3/2008 “We have plenty of capital going forward and we don’t need to come back into the equity market.”
  • 4/10/2008 Merrill cash “is sufficient for the foreseeable future.”
  • 4/8/2008 “We deliberately raised more capital than we lost last year… we believe that will allow us not to have to go back to the equity markets in the foreseeable future.”
  • 4/22/2008 Merrill Lynch raises $9.5 billion via debt and preferred stock offerings.
  • 5/7/2008 “We have no present intention of raising anymore capital.”
  • 7/17/2008 “Right now we believe that we are in a very comfortable spot in terms of our capital.”
  • 7/28/2008 Merrill sells $8.5 billion in capital.

If you feel like your head is about to explode, I’m right there with you. This kind of behavior normally wouldn’t fly even at a middle management position in a regional corporation. And this is the CEO of Merrill Lynch!

The only thing I can think of is that John Thain must have secretly proclaimed 2008 “opposite year,” the year in which he would do the exact opposite of what he said. Either that or he has some kind of short-term memory issue a la the film Memento.

In light of this, I was particularly interested by Thain’s Monday comment that Merrill Lynch would soon return to profitability. He also commented that the firm won’t need additional capital after its recent $8.5 billion efforts.

I’m guessing negative on both of these claims.

Let’s consider the bank’s recent sale of $30 billion worth of credit default obligations (CDOs). Merrill valued the CDOs at $11.1 billion on its balance sheet, which means the firm had already written off $20 billion worth of their value.

Besides this, Merrill sold the CDOs for $6.7 billion ... and it provided 75% of the financing ... AND it will have to take the CDOs back onto its balance sheet should they default.

Thus, Merrill Lynch sold $30 billion worth of junky paper for a little under six cents on the dollar ... AND it is still responsible for picking up the tab, should the CDOs default. If we’re truly blunt about the deal, Merrill raised about $5 billion in cash and the whole CDO issue was a front.

With these kinds of deals—selling garbage for pennies on the dollar while remaining on the hook for potential defaults—it's little wonder that Merrill’s CEO never seems to know how much capital or write-downs the company will require. After all, according to this recent deal, the very same CDO could be written down, sold, and then written down again!

But at least the company is well capitalized ...