Merrill Offloaded Billions to Allay CDO Concerns

The controversial decision by Merrill Lynch to offload billions of dollars in risky assets at bargain-basement prices came after the big Wall Street firm faced growing concerns from counterparties on trades as well as retail brokerage customers over the massive size of the bad bonds still on its books, people close to the firm say.

Merrill Lynch
Merrill Lynch

The big Wall Street firm did not face a funding crisis, these sources say. Rumors of a possible funding crisis caused shares of Merrill to tank about 10 percent. Merrill announced its capital raising and addition writedowns after the market closed on Monday.

But officials at the firm, including CEO John Thain made their move after growing skittishness from investors and customers about the growing possibility of further writedowns in the future, according to people close to the firm.

People close to Merrill also say timing was important; The hedge fund, Loan Star was willing to buy Mmerrill's troubled collateralized debt obligation (CDO) portfolio, albeit at a steep discount and with many strings attached. But people at Merrill worried that if they didn't make the deal happen fast, other firms with risky assets would jump ahead, forcing Merrill to sell later at even less advantageous terms.

The reason behind Thain's move to write down billions of dollars in debt, and raise addition capital just weeks after he announced a second-quarter loss, the sales of assets to raise money, and a massive writedown is unprecedented.

Compounding the problem for Merrill has been Thain's public statements, in which he has said at various times that that the firm didn't need new capital to plug budget holes, and then that he didn't need to sell stock to raise new money amid additional writedowns just before the firm sold assets and issued stocks.

Indeed, many analysts questioned the plan announced by Merrill as a gimmick because the firm financed 75% of the CDO sale, meaning that the fund that purchased its CDO portfolio may be responsible for only 25% of price the CDOs. If the prices of the CDOs slide more than 25 percent, Merrill could be on the hook for the rest.

Still, David Trone, an analyst from Foxx Pitt Kelton said Merrill had no choice but to cut the best deal it could and cut the deal fast. "Counterparties were getting worried," Trone said, "and Merrill was definitely hearing from investors in the retail system that the portfolio of CDOs were too big."

Some analysts may have had problems with the deal, but the market was obviously impressed. After sliding this morning, prices of Merrill's stock rebounded as investors viewed Merrill's decision to get rid of the bad debt as a positive.

A spokeswoman for Merrill had no immediate comment.