NEW YORK (AP) – Investment bank Merrill Lynch & Co. said Friday credit and mortgage woes will lead it to post a third-quarter loss, as it takes almost $5 billion in writedowns in the wake of a credit crunch that paralyzed Wall Street this summer.
The bulk of the losses will come from marking down the value of complex instruments known as collateralized debt obligations or CDOs, and from declines in subprime mortgages — loans given to customers with poor credit history.
Credit rating agencies Moody's Investors Service and Fitch Ratings both placed Merrill Lynch on a negative outlook based on the expected quarterly losses. That means the agencies could lower Merrill Lynch's ratings in the coming weeks, making it more expensive to borrow money.
Rising delinquencies and defaults on mortgages, especially subprime ones, have led to the near disappearance of investors willing to buy the loans. Without an investor market, the value of the loans decreased, leading to writedowns of portfolios. Subprime mortgages are often used in CDOs, pushing their value lower as well.
In total, Merrill said it would report a loss of up to 50 cents per share for the quarter — its first loss since the third quarter of 1998. Analysts polled by Thomson Financial, on average, forecast earnings of $1.24 per share for the quarter ending Sept. 30.
About $4.5 billion of the writedowns are related to the declining value of subprime mortgages and CDOs. Merrill Lynch said it took significant steps to reduce its exposure to the subprime market in the third quarter.
Buckingham Research Group analyst James Mitchell said in a research note the writedowns were larger than excepted, but “the direction was not surprising given their position as the No. 1 CDO underwriter and their recent acquisition of First Franklin, a subprime originator.”
Merrill Lynch agreed in September 2006 to acquire First Franklin, one of the largest subprime lenders in the nation, for $1.3 billion from National City Corp.
Merrill Lynch is also writing down another $463 million, net of related fees, on the value of financing commitments for corporate buyouts, regardless of when the deals will close or fund. Many investment banks got stuck this summer with loans they pledged to private-equity firms for major acquisitions.
Merrill Lynch reduced these commitments to $31 billion at the end of the third quarter, down from $53 billion at the end of the second quarter.
Sandler O'Neill & Partners analyst Jeff Harte wrote in a research note the total commitments outstanding were well above expectations. Harte had projected Merrill Lynch might be able to cut its commitment to the $20 billion range by the end of the third quarter.
Despite the third-quarter declines, Merrill Lynch's chairman and chief executive, Stan O'Neal, said in a statement market conditions have shown improvement and are returning to more normal levels.
Merrill Lynch was not the only institution this week to announce its earnings would take a significant hit. On Friday, Washington Mutual Inc. said its third-quarter earnings would tumble 75 percent on loan writedowns and substantially higher provisions for loan losses.
Citigroup Inc. said its quarterly earnings would fall 60 percent, as it planned to write down more than $3 billion in securities backed by underperforming mortgages and loans tied to corporate bonds.
Shares of Merrill Lynch rose $1.82, or 2.4 percent, $76.60 in afternoon trading. In general, shares of financial institutions have risen recently after warning of substantial losses, as investors take the caution to mean the worst of the credit crisis is over.