The Wall Street Journal-20080118-More Zeroes for Investors- As Subprime Write-Downs Top --36-100 Billion- Dow Industrials Drop 306-95 Points- Small Investors Brace for More- -1-
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More Zeroes for Investors; As Subprime Write-Downs Top $100 Billion, Dow Industrials Drop 306.95 Points; Small Investors Brace for More; [1]
With mortgage-related losses at big banks and brokerages now topping $100 billion, Wall Street is going back to basics.
A number of businesses that fall under the umbrella of structured finance, from packaging mortgages to big corporate loans, have been hit hard, forcing companies such as Merrill Lynch & Co. and Citigroup Inc. to focus their energies on sometimes less-profitable but steadier businesses.
After announcing nearly $15 billion in fourth-quarter write-downs yesterday, Merrill Chief Executive Officer John Thain emphasized the importance of the firm's bread-and-butter business of selling stocks and bonds to investors, which has taken a back seat in recent years as the firm pushed into riskier areas. This week, while preparing to unveil the worst results in the firm's 94-year history, Mr. Thain flew to Arizona for a day to meet with management in the firm's wealth- management unit.
"I think Merrill Lynch is known for its client focus and its wealth- management businesses," Mr. Thain said in an interview. "We are still going to have a trading component to our business, but it is not going to be of the same nature."
Merrill's stock dropped $5.64, or 10%, to $49.45 on the New York Stock Exchange, leading a marketwide decline. The Dow Jones Industrial Average tumbled 2.5%. Merrill declined because its losses more than doubled analysts' expectation for a loss of $4.93 a share, and on fears that some bond insurers that hedge some of Merrill's remaining roughly $30 billion in mortgage assets may lose their triple-A credit rating.
By recognizing that its hedges with one insurer may be worthless, Merrill confirmed the validity of investors' past worries about its remaining exposures to several others, said analyst David Trone of Fox-Pitt Kelton. "While investors have for some time worried about new areas of exposure, Merrill's impairment actions in these areas officially marks the transition from possibility to realization," Mr. Trone said.
Like Merrill, other big financial players are undergoing similar shifts as they pull back from riskier businesses. Big banks such as Citigroup are holding on to more of the loans they make, rather than sell them to investors. That requires that they set aside more capital on their balance sheet, a move that drags on future earnings growth.
Financial firms "are going to have to slow things down," said David Hendler, senior analyst at CreditSights. "They're going to see less transaction volume and less complexity; there will be more of a focus on generic product lines."
The result: Banks and brokers, whose returns in recent years have regularly topped 20% and at times 30%, are more likely to see this measure of profitability fall to the "mid-to-high teens in good years and high single digits in the bad years," Mr. Hendler said.
Overall, the losses experienced by major financial players are shaping up to turn the housing bust and ensuing credit crunch into a calamity that will rival, and likely surpass, previous financial crises. The $100 billion in losses racked up on Wall Street compares with about $170 billion in losses from the savings-and-loan crisis in the late 1980s and early 1990s, according to Lawrence J. White, an economics professor at New York University.
Both figures may seem small compared with the $2 trillion in wealth lost following the bursting of the tech bubble, but the more than $100 billion in subprime write-downs on Wall Street is the tip of an iceberg.
Some housing experts suggest that home prices will have to fall 20% to 30% to return to realistic levels. That could result in an overall loss of wealth in the U.S. of $4 trillion to $6 trillion, according to Prof. White.
Yesterday, Merrill announced write-downs totaling $11.5 billion and said it expects losses of $3.1 billion to reflect sour hedges with bond insurers. Merrill recorded a fourth-quarter net loss of $9.83 billion, compared with a year-earlier net income of $2.3 billion.
Mr. Thain is moving to get Merrill's house in order after a year that resulted in the ouster in October of his predecessor Stan O'Neal.
Mr. Thain, who took over as CEO in early December, raised $12.8 billion in additional capital for Merrill. He said the amount of capital Merrill raised exceeded the firm's $8.6 billion loss from continuing operations for all of 2007. He added he wouldn't consider selling the firm's $13 billion stake in BlackRock Inc., an asset- management company, because it has strategic value to Merrill. He ruled out selling the firm's 20% stake in media company Bloomberg LP, because of the income it brings in to Merrill.
The former NYSE Euronext CEO has also significantly reduced Merrill's exposure to some of the exotic mortgage products that got the firm in trouble. Merrill's exposure to collateralized debt obligations was $4.8 billion as of Dec. 31, compared with $15.8 billion three months earlier. CDOs are pools of debt, including subprime mortgages, that have been repackaged. For the same periods, exposure to subprime-residential mortgages fell to $2.71 billion from $5.66 billion.
Mr. Thain was skeptical that Merrill could recover much value from most of its mortgage assets, even if more buying power returns to the market in 2008.
"I think it's not likely that these things are going to recover," he said, "because the fundamental assumptions as to home price declines and cumulative losses. . . I think we're being conservative, but I don't think that we're likely to get much back on these things."
To help shore up Merrill's risk-management practices, Mr. Thain announced that Noel Donohoe, the former risk czar of Goldman Sachs, where Mr. Thain worked as co-president, will head risk management at Merrill alongside Ed Moriarty, who became chief risk officer in September.
Messrs. Donohoe and Moriarty will report directly to Mr. Thain, who says he will reinstate a firmwide risk committee. Previously, risk was managed by multiple committees, which often didn't have a full picture of the firm's risk profile.
"We will continue to take risks," Mr. Thain said. "None of the trading businesses should be taking risks, either single positions or single trades that wipe out the entire year's earnings of their own business, and of course certainly shouldn't take a risk to wipe out earnings of the entire firm."
