Banking, finance, and taxes

Merrill Lynch (MER): "We don't need cash!!! We need cash!!!"

Merrill_lynch_logoIf you reviewed our technical break-down call in Merrill Lynch (NYSE: MER) today at Volume Spike you might not be surprised about tonight’s news.  The brokerage and investment banking firm is raising capital and trying to clean the garbage out out of its vaults. 

On the surface this flies right against what the company’s management team has said in recent weeks and months.  Unfortunately, it looks like the "we won’t do anything non-dilutive" expectations were more myth than fact. 

Here are some actions being taken:

  • it will issue new common shares with gross proceeds of approximately$8.5 Billion through a public offering launched today (excluding $1.3Billion in over-allotments) with Temasek Holdings (Singapore sovereign wealth fund) buying$3.4 Billion of common stock in the public offering;
  • exchange the outstanding mandatory convertible preferred securities forcommon stock or new preferred securities, eliminating reset features inoriginal securities;
  • executive management will buy approximately 750,000 shares of common stock in the public offering by executive management;
  • a sale of U.S. super senior ABS CDO’s to reduce exposure by $11.1 Billion from June 27, 2008;
  • will terminate ABS CDO hedges with monoline guarantor XL Capital and settle negotiations with other monoline counterparties.

If you lump all the dilutive efforts here Merrill Lynch expects apre-tax write-down of $5.7 Billion in Q3, which is comprised of a $4.4Billion from the sale of CDOs, $500 million net loss hedge terminationswith XL Capital Assurance, and about $800 million maximum lossesrelated to the potential settlement of other CDO hedges with monolinecounterparties.

Merrill Lynch also sees $2.5 billion in expenses related to a resetpayment to Temasek and $2.4 Billion of additional dividends from themandatory convertible preferred stock exchange.

Merrill Lynch agreed to sell $30.6 Billion gross notional amount ofU.S. super senior ABS CDOs to an affiliate of Lone Star Funds for apurchase price of $6.7 billion, and the difference between its recorded$11.1 Billion carry value is where the $4.4 Billion charge above comesfrom.  This will reduce exposures from $19.9 Billion at June 27, 2008down to $8.8 Billion (majority is vintage collateral of 2005 and older).

What is interesting here is that Merrill Lynch will provide financingto Lone Star for these CDO’s for approximately 75% of the purchaseprice.  There are more terms if you review the release.

Shares closed down over 11% at $24.33.  What is interesting here isthat shares had dropped over 3% more and were looking at new 52-weeklows right after the news.  Shares are actually up just under 1% at$24.40 now in after-hours trading.  This $8.5 Billion raised will effectively dilute shareholders by about 20%.

Jon C. Ogg
July 28, 2008

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