Analysts cut their views of Merrill Lynch & Co.'s first quarter to a loss Thursday, saying continued deterioration in markets used to value complex forms of debt will cause the investment bank to write down billions of dollars in assets.
Oppenheimer & Co. analyst Meredith Whitney now sees Merrill writing down $6 billion in its first quarter, and BernsteinResearch analyst Brad Hintz expects $4.5 billion in write-downs. Both analysts had expected the bank to post a profit, but now see steep first-quarter losses: Whitney predicts a $3 per share loss and Hintz predicts a loss of $1.60 per share.
Merrill shares were down 0.2% to $44.34 in recent trading.
A Merrill spokeswoman declined to comment on the analysts' projections.
The falling values of the indices also caused Whitney to cut her first-quarter estimates to a loss for the Swiss bank UBS AG and for Citigroup Inc. She said Thursday she expects UBS to write down $11 billion in assets during the first quarter; on Wednesday she predicted that Citigroup will write down $13.1 billion. A UBS spokesman declined to comment on Whitney's research.
Shares of UBS were up 2.2% at $29.80 each in recent trading.
The potential write-downs facing Merrill and the world's other giant banks again put the spotlight on an obscure set of derivative indices used to estimate the value of thinly traded assets on the balance sheets of large banks. Critics of the indices believe they are too volatile, too illiquid and too susceptible to market manipulation to fairly value assets.
Drops in the value of indices have become one of the most significant factors in estimating the quarterly performance of large banks.
"Estimating the earnings of Merrill Lynch has become a game of estimating what the next write-down will be," Punk, Ziegel & Co. analyst Richard Bove wrote in a research note Thursday.
Bove also cut his full-year profit view for Merrill Thursday to nearly a third his previous estimate, but protested the mark-to-market accounting rules that made banks like Merrill tie the value of their assets to derivative indices such as the ABX, CMBX and LCDX. Those indices track the value of securities tied to residential and commercial mortgages, as well as LBO loans, and have been falling sharply this month.
"One can make just about any estimate because there is no hard data to base the number on," Bove wrote. "More importantly, one must ask again if the base indices have any validity."
Federal Reserve Chairman Ben Bernanke said in testimony before Congress last month that mark-to-market accounting is "one of the major problems we have in the current environment," though he said there was no obvious alternative. Barney Frank (D-Mass.), chairman of the U.S. House of Representatives Committee on Financial Services, has said the committee will review the mark-to-market rules, and said they may be having a "downward pull" on the economy.
Whitney predicts that write-downs will prompt large banks to raise new capital beginning in April, "as net losses wipe out a material portion of new equity raised in the past three months." Separate from replacing capital lost from write-downs, the banks may have to raise even more capital if rating agencies downgrade the ratings on their assets, Whitney said, since lower-rated assets require higher capital ratios.
Write-downs at Merrill and UBS are expected to come from the banks' portfolios of subprime collateralized debt obligations, securities tied to commercial real estate, loans funding leveraged buyouts and Alt-A mortgages.
The analysts are watching Merrill particularly closely because of its large exposure to collateralized debt obligations.
"Unlike in past cycles, this time around MER has found itself with the largest balance sheet exposure to CDO assets among the large capitalization brokerage firms," Hintz wrote. "With $30.4 billion of CDOs still on Merrill's balance sheet at the end of 2007, we believe the 'CDO Overhang' will be an ongoing concern for the firm over the next twenty four months."
Hintz said that, since the credit market indices accelerated their fall in March, which will make Merrill's write-downs worse than the relatively light hits taken by banks with first quarters ending in February: Lehman Brothers Holdings Inc., Goldman Sachs Group Inc. and Morgan Stanley.
The trio reported earnings last week and each wrote down roughly $2 billion in assets.
