Credit losses aren't done yet
Merrill's sale of toxic debt raised hopes, but Wall Street's pain isn't over yet.
 |
| Merrill Lynch last week sold off "the best" of its worst mortgage-related debt, according to a source involved in the trade. |
NEW YORK (Fortune) -- Merrill Lynch's fire sale of toxic mortgage debt last week has generated hopeful discussion about the beginning of the end of the credit crisis being at hand.
But a review of some lesser-noticed events of late suggests that the pain is far from over.
For starters, Societe Generale, the big French bank, on Tuesday announced an $890 million write-down for mortgage-related debt in its latest earnings report.
The charge comes as the bank shops a big block of mortgage-backed securities known as collateralized debt obligations - described by one participant in the trade as "over $5 billion" - to clean up its balance sheet. SG's total writedowns of subprime mortgage and CDO-related assets have already amounted to about $7.3 billion.
In a sign of investors' newfound hopefulness, SG's stock rose in part because the size of the bank's writedowns shrank. In January the bank wrote down approximately $3.5 billion. SG declined comment.
Then there's Lehman Bros. (LEH, Fortune 500), which has suffered as much as any Wall Street player from the housing downturn. But now the commercial real estate market is suffering too as economic growth slows to a crawl. And Lehman is a big player there. The New York Post reported last week that the bank is shopping its entire $29.4 billion commercial mortgage-backed security portfolio.
The prospect of a sale prompted a lengthy analysis by Bernstein Research's Brad Hintz, a former Lehman chief financial officer. Hintz concluded that Lehman could book between a $2.8 billion and $4.9 billion loss on the trade, pre-tax, were it to be concluded prior to the third quarter's end. A Lehman spokesman declined comment on the Post report and Hintz's analysis.
Finally, there's Merrill (MER, Fortune 500). It won plaudits last week for aggressively moving to unload $30 billion of mortgage-related debt off its books, even at the bargain price of 22 cents on the dollar. (That $30 billion was face value. Merrill had already written down the securities' value to $11 billion.)
The good news is that Merrill's exposure to CDOs is now under $10 billion. The bad news, according to a securitized products salesman involved in Merrill's trade, is that the affiliate of Dallas-based Lone Star Funds that purchased the CDOs bought "the best, and left [Merrill] the rest."
According to this executive, Lone Star purchased so-called super senior CDOs. Those bonds are the most insulated from losses in their underlying collateral. The CDOs that take a hit earlier, the so-called mezzanine slices, are still on Merrill's books.
Mezzanine CDOs are virtually worthless today, especially if their collateral is debt from 2006-2007, the years where mortgage underwriting standards were considered to be the most lax.
Prior to the Merrill-Lone Star deal going through, Merrill is said to have turned down a bid of eights cents on the dollar for a block of 06-07 mezzanine CDOs. A Merrill spokeswoman declined comment.
If the housing market does bottom out soon, Merrill's decision to hang on could prove smart as the value of those bonds would presumably rise. But if not, the bank may regret not taking what it could get.
On the other hand, Merrill has kept several billion dollars worth of super-senior CDOs from 2004-2005, when underwriting standards were higher. These bonds are said to be valued between 30 and 40 cents on the dollar. Today, that passes for something like rock solid. 
-
The retail giant tops the Fortune 500 for the second year in a row. Who else made the list? More -
This group of companies is all about social networking to connect with their customers. More -
The fight over the cholesterol medication is keeping a generic version from hitting the market. More -
Bin Laden may be dead, but the terrorist group he led doesn't need his money. More -
U.S. real estate might be a mess, but in other parts of the world, home prices are jumping. More -
Libya's output is a fraction of global production, but it's crucial to the nation's economy. More -
Once rates start to rise, things could get ugly fast for our neighbors to the north. More
