Merrill Lynch warned on Friday that shaky credit markets forced the world's largest brokerage to reduce the value of securities linked to risky subprime mortgages and other products, a move that could hurt third-quarter profit.
Merrill shares initially fell 3.5 percent on the news before regaining most of that lost ground.
The announcement will be closely watched as a potential danger signal for other large U.S. brokerages and investment banks that report earnings next week. Wall Street heavyweights Goldman Sachs, Morgan Stanley, Bear Stearnsand Lehman Brothers also are exposed to subprime loans and products being roiled in the credit markets.
But Kathleen Shanley, an analyst at independent fixed-income research firm GimmeCredit, was disappointed that Merrill Lynch didn't provide more details. She called the disclosure made in a U.S. regulatory filing "just a tease" with no specific numbers.
"Investment banks historically have been close-mouthed about the contents of their portfolios, and about how they make their money," Shanley said in a research note.
Merrill Lynch is one of the largest issuers of collateralized debt obligations. Its investment bank also packages pools of subprime loans into securities for investors, and Merrill is exposed to the crisis in the subprime lending industry through its First Franklin Financial unit.
Merrill paid $1.3 billion for First Franklin in late December, and some analysts have said they expected the company to write down a portion of that amount amid escalating mortgage defaults in the subprime sector.
Merrill Lynch's retained stake in securitized assets, including residential mortgages packaged into bonds, was $10.3 billion at the end of June.
The company said credit market conditions had remained challenging in the third quarter. It cited the volatility surrounding risky subprime mortgages, CDOs and other structured credit products.
Bernstein Research analyst Brad Hintz said in a research note on Friday that Merrill Lynch and Morgan Stanley should emerge less bruised and battered by credit risk repricing and the mortgage-backed securities meltdown than their peers.
Merrill Lynch said it made the disclosure in anticipation of closing its acquisition of First Republic Bank, which is scheduled for Sept. 21.