Merrill CEO: 'Mistakes' Led To Huge Write-Downs

Merrill Lynch Chairman and CEO Stan O'Neal told shareholders Wednesday that the company made "mistakes" in its subprime lending exposure that led to $7.9 billion in net write-downs for the third quarter.

AP Stanley O'Neal

Standard & Poor's on Wednesday cut its ratings on Merrill Lynch after the investment bank's "startling announcement" that it posted a $2.3 billion net loss for the third quarter.

S&P cut Merrill's counterparty credit rating one notch to "A-plus," the fifth highest ranking, from "AA-minus," The outlook remains negative, indicating an additional cut is likely over the next few quarters.

The financial giant posted its first quarterly loss in six years due to bad bets on subprime mortgages and collateralized debt obligations.

"The bottom line is we got it wrong by being overexposed to subprime, and we suffered as a result of an unprecedented liquidity squeeze and further deterioration of the market," O'Neal said during a conference call. "No one is more disappointed than I am at that result."

The company warned that more write-downs could be coming if the world's largest brokerage further cuts the value on its remaining $20.9 billion exposure to asset-backed CDOs and loans to people with weak credit. O'Neal said the company is still working to resolve the impact of subprime mortgages.

"I'm not going to talk around the fact that there were some mistakes that were made," he said. "We, I, am accountable for those mistakes just as I'm accountable for the performance of the firm overall."

Merrill was the only big Wall Street firm to post a third-quarter loss. And its write-downs -- before hedges -- was bigger than the combined $3.6 billion in write-downs and charges recorded by rivals Goldman Sachs, Bear Stearns, Morgan Stanley and Lehman Brothers .

"This is a bloodbath for certain. It speaks very poorly to Merrill's risk management practices," said Bill Fitzpatrick, an analyst at JohnsonFamily Funds in Racine, Wisconsin, which invests $1.8 billion but does not own Merrill shares.

"Clearly, heads are going to roll, and I wouldn't be surprised to see meaningful near-term layoffs," he said.

Merrill reported a net loss of $2.3 billion, or $2.85 a share, from continuing operations in the third quarter, compared with a profit of $3 billion, or $3.14 a share, a year earlier.

The $7.9 billion of write-downs was more than the $5.5 billion Merrill forecast earlier this month. After reexamining its positions on collateralized debt obligations, it used more conservative assumptions for valuing those assets.

Merrill said the net write-down figure does not include a $967 million write-down, before fees, on commitments that include loans for takeovers.

O'Neal cited continued uncertainty in the market for risky subprime mortgages as defaults on those loans continue to escalate and sap the strength of the U.S. economy.

"We are working to resolve the remaining impact from our positions," O'Neal said in a statement.

He said the company has taken several measures to correct the issues that led to the writedowns and emphasized that outside of the subprime problems the company performed well in its other activities.

"The strong performance of these businesses convinces me overall we are on the right path," O'Neal said.  "Outside of mortgages our execution has been consistent."

Camilla Petersen, an analyst who covers financial stocks for Atlantic Equities in London, called the losses in Merrill's fixed-income portfolio "pretty spectacular."

"I think it shows two things: sloppy risk management and very aggressive risk taking," Petersen said. "They've tried to diversify away from their core strengths which are equities, investment banking and wealth management, all of which did very well during the quarter."

She said Merrill has a track record of going into businesses in a big way and then having to retrench.

"Merrill did that with energy -- entered the business and exited and now has gone back in," she said, citing one example.

Merrill shares are down 28 percent this year and fell before the third-quarter results were released as investors anticipated the bigger-than-expected write-downs.

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