Merrill’s outlook is “uncertain” with capital weak

July 23, 2008
Singapore Democrats

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Ambereen Choudhury
Bloomberg

Despite massive writedowns and capital injection from Temasek, Merrill says it’s outlook is still uncertain.

The outlook for Merrill Lynch & Co.’s credit rating is “uncertain” as the company’s equity capital position is weak relative to competitors, said Brad Hintz, a New York-based analyst at Sanford C. Bernstein & Co.

With the first anniversary of the credit crisis approaching, Merrill remains more susceptible to losses from mortgage-backed securities and collateralized debt obligations than Goldman Sachs Group Inc., Morgan Stanley or Lehman Brothers Holdings Inc., Hintz said. CDOs are securities packaged from other bonds, many link

“With $19.9 billion in CDOs still frozen on the balance sheet and with counterparty risk rising on the hedges underlying these troubled positions, the potential for additional material writedowns remains a concern,” Hintz said. The New York-based firm’s credit rating was cut last week by Moody’s Investors Service to A2 from A1.

The third-biggest U.S. securities firm probably will report a loss of $6.57 a share this year, compared with an earlier forecast of $1.07, Hintz said. The revised estimate assumes the company generates no earnings in the second half. Merrill will earn $3.17 a share in 2009, said Hintz, who reduced his 12-month price target for the stock to $30 from $45 and retained his “market perform” investment rating.

Stock slump

Analysts at Keefe Bruyette & Woods Inc. have a $36 price target. “Risks to our established price target may include a general decline in the overall value of the major indices, the reluctance on the part of retail investors to invest in stocks and bonds, a decline in the overall level of equity and fixed- income underwriting as well as mergers and acquisitions,” analysts Lauren Smith and Joel Jeffrey wrote in a report to clients today.

Merrill rose 18 cents to $30.91 in New York Stock Exchange composite trading on July 18. The company’s stock dropped 61 percent during the past 12 months.

The most significant risk facing Merrill is the possibility that the company will have to raise common equity, Hintz said. If Merrill sells more than $1 billion of stock or securities convertible into common equity, the firm would have to issue additional shares to ensure that investors that participated in the $6.6 billion capital raising in January, including Singapore’s Temasek Holdings Pte, don’t see their holdings diluted, he said.

Moody’s report

“This makes any potential common equity raises prior to January very dilutive to current shareholders,” Hintz said.

Moody’s downgraded Merrill’s credit rating on July 17 because “managements options to sell assets or raise more common equity to offset unexpected losses are now reduced given the difficult industry and capital markets environment.” Merrill may have to take an additional $10 billion of pretax writedowns related to its holdings of mortgage securities, Moody’s estimates.

“If losses exceed this amount, then further negative rating actions are likely,” Moody’s said. Merrill reported a second- quarter net loss of $4.65 billion after $9.7 billion of credit- market writedowns.

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