Merrill writedowns throw light on risk management

Merrill Lynch has released a warning on its third-quarter results. The bank said its mark-to-market losses on its collateralised debt obligation (CDO) and leveraged finance operations would be up to 50 cents a share.

The bank warned that it would make an estimated $4.5 billion of writedowns on its CDO and subprime mortgage holdings, citing an unprecedented move in credit spreads and a lack of market liquidity.

There will also be an estimated $967 million of gross losses on its leveraged finance operations, although the bank notes total exposure in this sector was reduced by 42% to $31 billion at the end of the third quarter, with the writedowns at $463 million net of related underwriting fees.

"The net losses related to these commitments were limited through aggressive and effective risk management," said Merrill Lynch.

The rating agencies, however, have taken a dim view of these developments - both Moody's and Standard and Poor's revised their outlooks on Merrill Lynch to negative.

In a research update released by Standard and Poor's, the rating agency singled out the CDO exposure as particularly worrying.

"The massive loss related to CDOs and subprime mortgages is particularly surprising: it suggests an exposure to these asset types that has been more significant than we had previously assumed, and it raises concerns over Merrill Lynch's risk management practices in allowing such a large exposure to build," the agency said, adding that solid performance in other areas would mitigate this loss.

Moody's said the writedowns, the largest for any bank so far to record losses in the CDO sector, also exceeded its expectations. As a result, its assessment of the quality of risk management at Merrill Lynch has diminished.

See also:

Credit Suisse and Citi expect profit losses for Q3
Credit and liquidity risk hammer earnings