Merrill Lynch reveals $7.9bn write-down

Banking giant's sub-prime losses 'staggering'; US property market falls worse than expected

A $7.9bn write-down by the investment banking giant Merrill Lynch has reignited controversy over how big the losses from the mortgage market crisis might yet turn out to be.

The figure, disclosed in the bank's quarterly results statement yesterday, was $2.4bn higher than it had predicted less than three weeks earlier, but analysts left a conference call with management still unclear as to why it had ballooned.

The hit that Merrill has taken on mortgage-backed debts ec-lipses anything previously seen on Wall Street, and yesterday's confusion led investors to fear the worst may still not be over. It came as the latest US housing market data showed a worsening picture for home sales, and before news last night of up to 3,000 job cuts at Bank of America.

Merrill Lynch's chief executive Stan O'Neal said the company had changed its assumptions on the future performance of the global market for mortgage-backed debts, which has all but seized up since low-income Americans began defaulting on mortgages in record numbers.

Mr O'Neal has spent two years playing catch-up with other banks that had more established businesses trading mortgage-backed debts, including complex derivative products called collateralised debt obligations (CDOs), and the subsequent blow-up raised questions yesterday about his long-term future at the company. Analysts – and Mr O'Neal himself – said it was clear the expansion had been done by taking on too much risk.

"The bottom line is we got it wrong by being over-exposed to sub-prime mortgages," he said. "I am accountable for the mistakes as I am accountable for the performance of the firm overall and my job, our job, the leadership team's job, is to address where we went wrong."

However, he refused to say what proportion of the bank's mortgage-backed debts had been revalued to the depressed market rate, and which were still being valued using a mathematical model. And although he insisted that Merrill was giving far more information than its peers, he would not say what percentage of the value of the debt portfolio had been written off.

Jeff Harte, finance industry analyst at Sandler O'Neill, said the most alarming part of the results was how different they were from the numbers put out by the company at its profit warning on 5 October. "Management noted that it re-examined its remaining CDO positions, taking more conservative assumptions, with additional analysis and price verification," he told clients. "We find the concept of dramatic retroactive valuation changes particularly concerning from a risk management standpoint. When one position is not accurately marked, neither hedging strategies nor aggregating risk can be done effectively."

Downgrading Merrill Lynch's corporate bonds yesterday, the rating agency Standard & Poor's called the announcement "startling" and the losses "staggering".

The $7.9bn write-down in the debt business was bigger than Merrill Lynch's entire profits last year, and sent the company $2.3bn into the red for the three-month period ended 30 September. The company said it expected its debt business to be substantially smaller from now on, and it would also look for ways to shore up its balance sheet. Staff bonuses will certainly be cut, job losses are likely in many areas of the bank, and the company may sell some of its non-core businesses and assets, such as a stake in the news organisation Bloomberg.

Over the past month, investment banks have written off tens of billions of dollars from the value of their portfolios of CDOs and mortgage-backed securities, complex debt products that have been created by repackaging ordinary residential mortgages bought up from local lenders.

Defaults on those underlying mortgages have soared as house prices have tumbled in many parts of the US. The mean price of a home changing hands in September was 4.2 per cent lower than a year ago, according to National Association of Realtors figures out yesterday, and the number of transactions was down 8 per cent, much worse than expected.

Last night, Bank of America said it plans to lay off 3,000 staff, and that the head of corporate and investment banking will depart after its $1.46bn trading loss on mortgage-backed debt. It said most of the job cuts will be in corporate and investment banking, and would be accompanied by a strategic review of the business.

Gene Taylor, a 38-year veteran of the bank, will retire at the end of the year as president of global corporate and investment banking, to be replaced by Brian Moynihan, now head of wealth and investment management.