Merrill jettisons mortgage junk, putting pressure on its peers

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From Times staff writer Walter Hamilton:

Will the fire sale at Merrill Lynch & Co. force similar moves by other investment banks?

That was the big question on Wall Street today following Merrill’s surprise decision to dump a huge chunk of troubled mortgage bonds for pennies on the dollar.

Merrill CEO John Thain said late Monday that the brokerage would sell so-called collateralized debt obligations once valued at $30.6 billion for a mere 22 cents on the dollar.

Analysts generally applauded the move, saying that clearing away the residue of the subprime mortgage bust was an essential step toward helping Merrill get its business back to normal.

The move also could help the economy. Some financial-industry critics say the longer banks and brokerages take to get past the subprime crisis, the greater the risk that they’ll plunge the economy into a prolonged downturn like the one that wracked Japan in the 1990s.

But blue-light specials for troubled assets can mean a lot more pain for shareholders. Merrill had to write off an additional $5.7 billion -- bringing its total subprime write-offs over the last year to almost $52 billion, according to Bloomberg data.

To bolster its withered capital, the company also issued $8.6 billion of new stock today, diluting existing shareholders by a whopping 38%.

The company’s shares dived 11.6% on Monday to a 10-year low before the announcement. The stock opened lower today but has rebounded with the broad market. With a few minutes to go in today’s session, Merrill was at $26.03, up $1.70, or 7%.

Merrill’s decision to jettison its toxic CDOs could put a lot of pressure on Citigroup Inc. in particular, several analysts wrote in notes to clients today.

Citigroup still has $22.5 billion of subprime assets, the largest of any investment bank, according to Meredith Whitney, an analyst at Oppenheimer & Co. UBS is next at $15.6 billion.

What’s more, Citigroup values its subprime portfolio at 55 cents on the dollar, according to William Tanona, an analyst at Goldman, Sachs & Co. Citigroup would have to write off $16.2 billion if it had to value its holdings at 22 cents on the dollar, Tanona said.

‘We continue to believe they would struggle to obtain their prices in the marketplace today,’ Tanona wrote.

Some analysts doubted Citigroup would match Merrill’s 22-cent valuation because Citi has long maintained that many of its mortgage holdings were originated before the excesses of the subprime crisis struck.

Nevertheless, Citi might have to write off an additional $8 billion this quarter, which could force it to raise more capital, according to Michael Mayo, a Deutsche Bank analyst.

‘The decision about raising new capital could be closer than we previously thought,’ Mayo wrote.

Still, Citi’s shares rallied today with the rest of the market: They were up $1.14, or 6.5%, to $18.57 shortly before the closing bell.