Thursday, October 16, 2008

ML & C Earnings

Merrill Lynch

== Headline loss of $5.56 per diluted share: $5.1 billion

== Net gain of $2.8 billion because their credit spreads widened. Yep, the old Lehman trick. They posted gains because the market believes that they pose an increased default risk. This is particularly bogus since they are being acquired by BAC.

== This quarter's earnings included the July sale of super-senior CDOs. To review, they sold $30.6 billion of these holdings at 21.9 cents on the dollar: $6.7 billion. They provided a $5 billion loan to the buyer, accepting the sold CDOs as collateral. This was a non-recourse loan, so Merrill could not lay claim to any other assets of the buyer. Therefore, the worst case scenario for Merrill is a net sale price of about 5.5 cents on the dollar. If the CDOs drop to zero, the buyer would just not pay the loan back and lose the $1.7 billion that they actually paid.

So where should this paper be marked today? Great question. My guess would be between 10 cents and 25 cents per dollar. Merrill was in a bind at the time and could not hold out for a stellar price. However, defaults are still rising and home prices are still falling (albeit at slower rates).

Merrill also settled their CDO hedge with XL Capital for 48.6 cents on the dollar or $500 million. This payment that Merrill received is also an important mark to market.


== Headline loss of $0.60 per share: $2.8 billion

== Citi only booked $1.5 billion in gains because their spreads widened

== Keep an eye on the Latin American operations. Delinquencies and credit losses are on the rise. Consumer credit losses hit 13.16% of average loans outstanding for the quarter.

== Citi's CDO positions have a weighted average mark of 47.1 cents on the dollar. How does this compare to Merrill's trade? Based on the level of the trade, I am guessing that the CDOs that Merrill sold were mezzanine tranches. This would tie out to the ABX market at the time: BBB- indices were trading around 5 cents on the dollar. Using the ABX market as a proxy, I would say that Citi is marking their inventory about 10.85 cents too high. The difference is about $3.7 billion.

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