From the September 2008 issue of Research Magazine • Subscribe!

Merrill Trims CDOs and Staff, as It Boosts Global FAs to 16,690

Merrill Lynch says it had a second-quarter net loss of $4.7 billion vs. earnings of $2.1 billion a year earlier. Second-quarter 2008 results include a pre-tax restructuring charge of $445 million related to headcount reductions. Its FA force and their results, though, remain intact, the company says.

"Our core franchise continues to perform well despite the extremely challenging market environment," says Merrill Lynch Chairman and CEO John A. Thain.

Global wealth management (or GWM), which includes Merrill's private-client operations, had second-quarter 2008 net revenues of $3.4 billion, down 5 percent from the second quarter of 2007. They were impacted by expenses tied to investments in FA workstations, online capabilities and international expansion, the company says.

Global private client had net revenues of $3.2 billion, down 3 percent from the prior-year period.

The global financial-advisor headcount was 16,690 at quarter-end, an increase of 30 FAs during the quarter and 490 from the second quarter of 2007, as GWM "continued to be successful in retaining and recruiting high-quality experienced FAs," according to company reports.

"FA turnover, particularly among first- and second- quintile FAs, declined during the quarter and continues to outperform the industry average," says CFO Nelson Chai.

"We also continue to realize success in our recruiting efforts, particularly in our top two quintiles where we added almost 140 FAs on a net basis (globally)," Chai explains.

Outside the Americas, Merrill Lynch's continued focus and investment in the GWM franchise increased international FA headcount by 11 percent year over year. Total client assets in GWM accounts remained at $1.6 trillion at the end of the 2008 second quarter.

During the quarter, net inflows of client assets into annuitized-revenue products stood at $8 billion, but net new money was negative $5 billion. "This represents our first quarter of negative net new money since the second quarter of 2003, and reflects seasonal client income tax payments and the merger-related departure of a significant institutional retirement client" according to Chai.

Merrill Lynch's overall net revenues were negative $2.1 billion in the most recent period, compared with positive $9.5 billion in the prior-year period. This includes losses totaling $3.5 billion related to U.S. super-senior ABS CDOs (or collateralized debt obligations comprised of asset-backed securities) and credit-valuation adjustments of negative $2.9 billion related to hedges with financial guarantors, about half of which were tied to U.S. super-senior ABS CDOs.

The company also had a net loss of $1.7 billion in the investment portfolio of its U.S. banks, as well as a loss of $1.3 billion from certain residential-mortgage exposures.

Net revenues for the second quarter were $7.5 billion, excluding these net losses, credit-valuation adjustments and a $91 million net benefit related to credit-spread widening on Merrill's long-term debt liabilities. This represents a revenue drop of 21 percent, year over year, and a slight increase from the first quarter or 2008, the company says.

Still, the company says its global wealth management, or GWM, operations have had "continued solid revenues, with recurring revenues greater than 70 percent of total net revenues."

To enhance its overall capital position, Merrill has sold its 20-percent stake in Bloomberg, L.P., to Bloomberg Inc., for $4.4 billion. Merrill Lynch is also in talks to sell a major stake of Financial Data Services, now part of its global wealth management operations, for some $3.5 billion. The company says it does not intend to sell its interest in investment manager BlackRock.

"We told you at the end of the first quarter that we were going to focus on expenses, and that we were going to reduce our headcount by 10 percent of our non-financial advisor headcount, that is about 4,000 people. We delivered on that promise," Thain says. "We have actually reduced our headcount by 4,200 people."

Financial analysts like Richard Bove of Ladenburg Thalman are not terribly impressed. "This is the fourth quarter in a row that the company has reported a loss. The total amount lost in this timeframe has been $19.2 billion," he explains.

"Even though it now has exemplary management, it could take years for the firm to recover," Bove says.

After releasing its second-quarter results in mid-July, Merrill announced a series of steps to reduce its risk exposures and to further strengthen its capital position, such as: o A substantial sale of U.S. super-senior ABS CDO securities, resulting in an exposure reduction of $11.1 billion; o An agreement to terminate ABS CDO hedges with monoline guarantor XL Capital Assurance Inc. and settlement negotiations with other monoline counterparties;o Plans to issue new common shares with gross proceeds of approximately $8.5 billion through a public offering (held July 29);o Agreement that Temasek Holdings of Singapore will purchase $3.4 billion of common stock, subject to regulatory approvals; and o Purchase of about 750,000 shares of common stock by executives.

As a result of these steps, the company says it should record a pre-tax write-down in the third quarter of roughly $5.7 billion. In the third quarter, Merrill Lynch also expects to record an expense of $2.5 billion related to its reset payment to Temasek and $2.4 billion of additional dividends.

At the end of July, Massachusetts securities regulators accused the firm of fraud for allegedly promoting the sale of auction-rate securities when the firm knew the investments were becoming increasingly unstable -- a charge Merrill denies.

"We are disappointed that Massachusetts filed this action because it ignores the only reason our advisors sold auction rate securities: They believed they were good investments for clients willing to trade some liquidity for higher return," the company says in a statement.

"The inarguable fact is the number of auctions that had failed in nearly two decades of (auction-rate securities) sales was small. In 2007, there were no failed auctions of securities sold to retail clients and, in fact, none to these clients until late January 2008."

But Massachusetts regulators claim that Merrill Lynch knew several months earlier "that auction markets were not functioning properly and were, in fact, in significant danger of collapsing."

The complaint cites a personal e-mail written by a Merrill Lynch executive on Nov. 19, 2007. "Market is collapsing. No more $2k dinners at CRU," said the e-mail, referring to a trendy Manhattan restaurant.

"We want Merrill Lynch to undo the damage they did by selling these things knowingly to people, telling them they had liquidity ... then leaving them stranded when they knew these auction markets were in trouble."

The complaint will be heard by a hearings officer within the Commonwealth's Securities Division. Merrill Lynch can appeal any finding in court.

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Janet Levaux, MBA/MA, is the managing editor of Research; reach her at jlevaux@researchmag.com.

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