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Subprime Exposure

Merrill Lynch took a beating for the third quarter 2007 as it posted the biggest subprime related write-down on Wall Street. The $8.4 billion write-down of Collateralized Debt Obligations led Merrill to post a $2.3 billion loss and resulted in the ousting of its Chairman and CEO Stan O’Neal. As of the third quarter 2007, Merrill still faces an exposure to $20.9 billion in subprime mortgages and Collateralized Debt Obligations

It is really bad isn’t it? Even as we are being told that all is okay on Wall Street, the banks and brokers are so full of disease it can easily be compared to necrotizing fasciitis. You know, that awful flesh eating disease.

The latest shenanigans by Merrill Lynch (MER) are almost too much to Bear (pun intended) and now we are going to surely continue with a crisis of confidence as it seems impossible for this group to allow the truth to come out when it speaks. Now Merrill is in a jam and it is trying everything to make it seem that all is just fine.

Bill Fleckstein had a few observations on this that just cannot be ignored:

So the question is: What changed in the past couple of weeks to cause a CDO — a package of loans known as a collateralized debt obligation — valued at 36 cents on the dollar to be “sold” last week at 22 cents? What did Thain know about this at the last conference call, and why was it not made clear to folks?

Of course, this is more a consignment sale than a true sale. Merrill is providing 75% financing on a non-recourse basis. That means it’s really receiving about 5 cents on the dollar. It may get the other 17 cents later, or it may get the securities back. In essence, Merrill wrote a put option “down 5 cents on the dollar” and gets a call option to get the other 17 cents.

Essentially, Merrill is putting up the funds to sell of the assets. Does that mean that the super-senior-debt they put up was sold for almost nothing? Why the payoff? What did Lone Star, Temasek or others have on them or even better, why did they unload the debt and lose the potential upside? Are they out of options?

The ugly factor is at an all time high. If Merrill goes down, it will not be because it was murdered, it will be because it kicked the chair out and hung itself.

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