Merrill Lynch: Unafraid of Contradictions

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 ...

Comments

[JasonC:]

By your own account, the company has successfully raised more than its market cap in fresh capital in the most difficult market in generations, and the permabears want to pretend it is a failing. This company has half a *trillion* in cash and cash equivalent short term investments. Half its balance sheet. They are going for overkill in terms of safety because of the ridiculous fears of the doom mongering short crowd. But Merrill will be there a generation from now as a result, when no one will remember who any of these short doom mongers are.

2008 Aug 05 01:38 PM

[Ishortyou:]

Greedy crooks in Banks and Broker firms wrapped subprime, credit cards, bad loans, etc. into structured finance vehicles i.e.: CDO-ABS-MBS-SIVs, they misled the market and bond insurers into these fraud and now everyone is paying the price with losses now the misleds have to clear up their books from that toxic waste! Rating agencies need to reinstate bond insurers triple A ratings once their books are cleared from toxic waste. AMBAC and MBIA are going in the right direction so it is just a matter of time before the get sound book of business again. Rating agencies will have to reinstate their tirple A ratings again.

2008 Aug 05 01:57 PM

[discov:]

who else is looking for a crash in MER when their 5 cent on the dollar, self financed, crooked accounting sale of bad assets comes back to bite their face off. Hahha ha ha ah

concisetrading.blogspo.../
Ryan

2008 Aug 05 05:54 PM

[JasonC:]

Lone Star is going to make a killing on that deal. Wait and see.

2008 Aug 05 06:45 PM

[Chris Marshall:]

If you look carefully at the MER 10Q (page 68) you will see that they financed $4.3B of the $4.4B Bloomberg asset sale. This is a moronic transaction, when you are trying to sell assets to raise capital.

If they are so desperate as to carry out the Bloomberg transaction on these terms, what are they hiding from us regarding raising capital and the state of their balance sheet.

2008 Aug 07 08:01 AM