Wow, Merrill is raising cash like there is no tomorrow. Which of course makes one wonder what they know that the rest of us don’t yet know.
From Bloomberg:
Merrill Lynch & Co. said it will record $5.7 billion of pretax writedowns in the third quarter because of additional losses on the sale of collateralized debt obligations and hedging contracts with bond-insurers including XL Capital Assurance.
The New York-based firm said today in a statement that it plans to raise $8.5 billion by selling shares in a public offering. Temasek Holdings, the Singaporean government investment fund that already is one of Merrill’s biggest investors, will buy $3.4 billion of stock in the offering, Merrill said.
Merrill Chief Executive Officer John Thain is pushing to rid the firm of its CDOs, which have contributed the majority of $18.7 billion of net losses reported over the past four quarters. Thain has had to raise capital to stave off credit- ratings downgrades and satisfy regulators that the firm can withstand losses.
“It does mark an attempt at curing the problem but at a tremendous cost to existing shareholders,” said Charles Peabody, an analyst at Portales Partners LLC in New York who recommends selling the shares. “You’re going to raise $8.5 billion in capital. How can you be pleased by that? It’s a necessity.”
Merrill said it sold $30.6 billion of CDOs to an affiliate of the Dallas-based investment firm Lone Star Funds, resulting in a pretax writedown of $4.4 billion. Merrill will provide financing for about 75 percent of the purchase price, according to the statement.
Ahem, note in our wonderful world of smoke and mirrors, a heavily-seller-financed sale is still a sale.
Reader S had these comments:
MER back to the well…that makes it $15B or so in the last few weeks
Bloomberg $4B
FDS $3.5B
New Offering $8.5BM. Whitney [of Oppenheimer, the analyst who has been the most accurate so far on the credit crunch] on the Q2 call
“Okay. Thanks. My second question is a broader question, and I appreciate it’s sort of easier asked than done, but given the fact that this is sort of the fourth quarter of material writedown for the company, and just knowing what your reputation is, I can imagine you are incredibly frustrated. And why not at this point be the first to purge assets and just get it over with? And if that means raising capital, that means raising capital. But you bring people to want to be long-term shareholders. Stock go down, just start fresh. What is the pushback on that? It seems like the most basic question out there. If you could just elaborate on that? Thanks.”
Looks like they listened….or have they? Time will tell.
Update: I had to run to replace a dead keyboard, and readers per comments did the heavy lifting on what this deal portends. Not pretty at all.
First, per the Wall Street Journal:
The biggest single action Merrill took Monday was the sale of mortgage assets to an affiliate of Lone Star Funds. Those assets had a face value of $30.6 billion, and Merrill was carrying them on its books at $11.1 billion as of the end of June. Lone Star paid just $6.7 billion for the assets, or 22 cents for every dollar of face value. The sale reduced Merrill’s holding of such assets by more than half, to $8.8 billion from $19.9 billion.
Read that twice. 22 cents on the dollar, and that with 75% financing. So the real price is lower or zero. Take your pick. And the urban legend in finance land (and I was a believer till just now) was that subprime paper had been marked down pretty well, but Alt-A and Option ARM still has a way to go.
Amazingly, the Journal says
Despite the steep discount, Merrill’s sale may bode well for other firms on Wall Street such as Lehman Brothers Holdings Inc. that are also sitting on hard-to-sell assets.
And how was the play, Mrs. Lincoln? And get a load of this:
Merrill’s decision to sell the mortgage assets was described by one person close to the company as an attempt to “lance the boil” and put the mortgage debacle behind it once and for all.
This looks more like an amputation of a gangrenous limb without anesthetic.
As for the fundraising, Merrill provided price protection to Temasek and other recent investors. As reader Burrite noted:
When Temasek invested $4.4 billion in December, the terms of the deal were that if MER raised any common equity at a price of less than $48, it would reimburse Temasek for the difference between the new offering price and $48. Assuming this deal occurs at $23, that means MER will pay $2.5 billion (of the $8.5 bn it is raising) to Temasek. Stated differently, it also implies that Temasek is buying 150 million new shares of MER ($3.4 bn/$23), and will be paying about $6-$7 for those shares, if you net out MER’s payment to Temasek.
And what does this portend for other holders of dubious paper? Merrill’s moves are decidedly bad news for other big credit market players, particularly Citi and Lehman.
Other good comments below.
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When Temasek invested $4.4 billion in December, the terms of the deal were that if MER raised any common equity at a price of less than $48, it would reimburse Temasek for the difference between the new offering price and $48. Assuming this deal occurs at $23, that means MER will pay $2.5 billion (of the $8.5 bn it is raising) to Temasek. Stated differently, it also implies that Temasek is buying 150 million new shares of MER ($3.4 bn/$23), and will be paying about $6-$7 for those shares, if you net out MER’s payment to Temasek.
Nice.
And why not at this point be the first to purge assets and just get it over with?
It would seem the answer is that he can’t find a buyer to do the deal at arm’s length for a decent amount of money. So they had to sweeten the offer by financing it.
I’ve seen a comment that part of the remaining 25% came from shorting the stock, which would be an easy take if you know the transaction.
The reason that MER (and others) cannot do a complete “mark” of assets or sale of unwanted assets is simple.
On a “mark” basis MER is insovent.
The banks and investment banks play this quarter by quarter game as they earn their way out of insolvency using the short/long spread engineered by our “good friends” over at the Fed.
Ta ta.
(Or perhaps tsk, tsk.)
From 30.6B face value to 11.8B book value until today, now 6.7B is a 79% haircut. Similar to ANZ bank and Nat’l Bank Australia. And these are super senior
tranches?? So were the ABX prices “distorted” after all?
We finally have a print on super-senior CDO, at 22 cents on the dollar. In a seller-financed deal.
So, how do Citi’s and Leh’s balance sheets look tonight? And what mark does the Fed have on the super-senior its loaning against?
This is a large plate of crow. At what point do we lose the ability to digest the change downward? And what’s the magic price that makes the market believe again?
Reuters – May 5, 2008: “John Thain told the Business Times he does not foresee the need to raise more capital, after the biggest U.S. brokerage raised billions of dollars, including from Singapore investment firm Temasek, after suffering massive subprime-related losses.
“Right now, our equity capital is $44 billion, which is just a little under its record high…We will change the risk management culture. Risk now reports directly to me”
So this means either: ML’s risk management time horizon is 2.5 months, or John Thain is especially prone to commiting type-one errors.
Either way, that just means the market will believe itself before it believes ML’s mgmt next time around…SEC endagered species list or not.
All liars, and all bankrupt.
Yves, I’ve been looking at this and posted to Mish and CR responses already. This gets uglier and uglier the more you read. They are financing 75% of the asset sales. There is 4.9bn (2.5 common, 2.4 preferred) of stock going to the existing equity and prefered as ratchet reset stock. This is based on 27.5 share price or so from closing on the 25th. So that will likely get higher. This is ABS which should include better asset classes then mortgages in it like credit card receivables and small business loans.
Barry Ritholtz brings up an extremely pertinent detail on his blog too about this matter.
“1. Why did Merrill fail to disclose this write-down to shareholders when they reported on July 17th? The stock was $30.73 then; everyone who bought since then just got totally sandbagged.”
EXACTLY!!!! There’s no a chance in hell they didn’t know about these CDO losses 10 days ago. Zero, and they said jack shit!! Where’s the SEC for frick sakes. They said nothing and anybody who bought since then has been deliberately and purposefully screwed. July 17th, they said nothing.. You can’t make this up, it’s too unbelievable…. This is a perfect example of the lack of credibility these firms have. CNBC better not spin this one tomorrow. ALOT of upset people over this.
Stuart…
They bought it Long, they’re great! If they shorted it you’d never hear the end of it..
Also, I’m wondering about that 22% number. Remember, MER is financing that 75% with the only recourse being the assets themselves. Help me out here, but wouldn’t that mean in the worst case scenario for Lone Star (they default next month or something that ridiculous) they’d be out of pocket only 1.675B? Help me out here, but I get 5.583% of nominal value out of pocket. That’s the risk Lone Star’s taking in these.
5.583% of the subprime/Alt-A/Mortgages on the books means everyone’s broke, right?
The way I see it, anyone else holding this type of paper has to, at a minimum, mark it to market assuming that the non-recourse loan will be paid back. Nobody can say that there is no market in these assets. That market is nominally 22 cents on the dollar and likely a lot less than that.
Still waiting for the first “mark up.”
Anonymous,
Well, going through the press release, attached below, they indeed did sell to Lonestar for immediate payment of only 25% of $6.7B ($1.675B)..so am with you here. Meaning from an original notional value, now written down to $11.1B, further written down to $6.7B, they’re only going to receive $1.675B or 5.583%, balance over payment terms. Sooo, yes, I’d say you have it. They’re all broke at these rates. And these were super senior…holy shit.
http://biz.yahoo.com/bw/080728/20080728006329.html?.v=1
Hey guys. MER is insolvent. Get it….?
There’s nothing there, only negative value. Pull out the calculators, it all adds up to less than nothing.
Econolicious
good comment I came across over at the tickerforum.
"An absolute disaster for MER (and other financials) on a few fronts:
1) The vintages inside these "sold" CDOs are 2005 and earlier. These are performing on orders of magnitude better than the 2006 & 2007 vintages. I can assure you that CDOs with 06 & 07 vintages are uniformly zeros if they are RMBS laden.
2) The "sale" is nothing of the sort. MER basically sold a call to Lone Star on the CDO. The recourse of the loan is limited to the CDOs only… in other words, Lone Star can "walk away" from the deal if losses in the CDO ramp up another $1.5 billion or so from current projections. In this event, MER would take back the CDO for what must be booked as a total loss (an additional $4 + writedown).
3) It's getting mighty tough to insist that these CDOs be marked to model when sales are taking place.
4) Investors can begin to look at the CDO inventory, broadly subtract out 80%+ haircuts and do their own valuations. The conclusion you reach is that the brokers are all insolvent as are a good many of the major money center banks. This could well start a run that will ruin many big names.
"
To paraphrase the old joke about the railroad car of onions, someone forgot to tell the brokers and banks that CDO’s are for selling not for holding.
Or how about all of those simple minded “old fashion people” who paid outlandish prices for tulip bulbs once upon a time. At least they got a pretty flower
Satyajit Das saw it coming why no one else?
I’m gonna take a stab at some numbers here.
At 6/30 MER had $16.1 bil in tangible equity, $16.34 in tangible equity per share, and a 1.55% ratio of tangible equity to tangible assets. (Yowsa!!)
So, pro-forma tangible equity (post-offering and write-downs) should approximate (in billions):
$16.1 + 8.5 (stock offering) + 3.5 (sale of Financial Data Services) + 4.43 (sale of Bloomberg stake) – 5.7 (new write downs) – 2.5 (payment to Temasek) = $24.33 billion
(I didn’t apply taxes to the asset sales because MER has plenty of NOLs to use up at this point.)
Shares outstanding, assuming a $22 offer price, are 985.4 mil + 386.5 mil = 1.372 bil shares
So, after the dust settles, tangible equity per share actually increases to $17.73/share, and tangible equity to tangible assets increases to between 2.5%-3.0% (depending on how much balance sheet shrinkage takes place), so leverage declines materially.
So, MER is clearly better off after all of these machinations, BUT… the biggest issue is the pricing of the equity offering. Are people willing to pay $22/share after this write-down debacle and what should be a pretty substantial loss of trust (both in MER and the financial group in general)? We’ll see. But I can see a bullish case being spun here (not that I’m buying it, of course.)
Oh, one other thing…
That $17.73 tangible book value per share is under the somewhat absurd assumption that the remaining assets are valued properly (which they’re undoubtedly not). For example, one could make the argument (as others already have) that the write-down of the sold CDOs isn’t done because of the manner of the sale. Also, I don’t know how big of a deferred tax asset MER has booked (under the assumption that the company will earn enough to utilize it). So, aside from the remaining Level III assets, there’s a lot of potential monkey business in the tangible equity calculation.
You know these vehicles are (over) leveraged or interconnected. It’s going to be like a bowling ball going down the lane and taking out all the pins.
Every other large i-bank on Wall Street is holding billions of super-senior CDO tranches – or being strong-armed to buy them back as they promised to make a market in them to all of their pension fund and municipal investors, not to mention sovereign wealth funds. It is a travesty that the SEC is focusing on short-selling, the State AGs have been left to deal with auction-rate securities (helllllooooo US Attorneys…oh right, they’re all Federalist Society-types), and no regulator is forcing the large i-banks to recognize these losses. The markets cannot recover while average investors have no faith in balance sheets.
And yes, Fannie’s and Freddie’s limits were raised to allow them to buy jumbo mortgages. It is really like a fun-house.
Can someone explain who thinks it is a good idea to prolong the misery this way? I feel as though Cox must be interviewing his way through the big three (Goldman, Morgan Stanley, JPM) and then when he lands a job for 2009, will maybe focus on the markets again. Alas.
“When Temasek invested $4.4 billion in December, the terms of the deal were that if MER raised any common equity at a price of less than $48, it would reimburse Temasek for the difference between the new offering price and $48. Assuming this deal occurs at $23, that means MER will pay $2.5 billion (of the $8.5 bn it is raising) to Temasek. Stated differently, it also implies that Temasek is buying 150 million new shares of MER ($3.4 bn/$23), and will be paying about $6-$7 for those shares, if you net out MER’s payment to Temasek.”
I think the math is wrong on this blog post.
The difference between $48/share and $23/share is $25/share. So under the previous agreement MER should be paying Temasek $25/share for 150million shares right?
Three small points that don’t seem to have been addressed, above.
First: since this paper is valued at 22c on the dollar, presumably at least some pieces are paying interest. I would bet big money that Lone Star is receiving (unless and until more pieces of the paper default) more money on the debt it purchased, than it is paying Merrill to own it through the seller financing, month by month. Merrill is paying Lone Star to take the debt off its hands and Lone Star is benefitting from positive carry.
2. As I read the press release, it only mentioned super-senior debt. Does MER hold any junior debt of RMBS or equity tranches still? If the super-senior debt is valued at 22c on the dollar, how do they value EQUITY tranches for crying out loud?
3. On the other hand MER does mention credit enhancements by monolines and “highly rated entities.” Perhaps MER is calling this paper “super-senior” by virtue of credit “enhancement,” while it might actually hold junior rank within its respective capital structures? Then it’s possible that what we are really seeing, is MER scrambling to get the debt off its books before the unmentioned monolines finally get their inevitable downgrades and are forced into runoff mode.
cramer brought up an interesting point:
“Lone Star owns Accredited Home Lending, which was formerly the 10th-largest subprime issuer, so it has some assumptions and some knowledge. It certainly wasn’t pantsed. That means we now have a legit benchmark that could get this stuff off the sheets of all of these firms. “