A Prescient Call on the Merrill Meltdown

In retrospect, calling the meltdown that led to $8.4 billion of credit losses at Merrill Lynch and the ouster of its CEO shouldn’t have been that hard. After all, the firm was the top underwriter of collateralized debt obligations, those packages of securities that were so hard hit by the subprime mortgage collapse.

But few analysts (or reporters for that matter) actually did. Not everyone missed it though.

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The hero of the moment seems to be William Tanona of Goldman Sachs Group. He predicted in a Sept. 26 research note that Merrill would have $4 billion in write-downs — from CDOs, other mortgage exposure and leveraged loans. Though he missed the mark by 50%, it is hard to hold it against him. When Merrill Lynch in early October announced its first estimate of the losses, the amount was only $1 billion more than Tanona’s.

(One analyst who wasn’t as prescient is Brad Hintz of Sanford Bernstein — and we love his Oct. 8 mea culpa: “Our analysis had previously concluded that [Merrill Lynch] was the least exposed to the fixed-income market among the large capitalization securities firms; that it took the least risk; and that it had the least to lose from the credit re-pricing event. We were wrong.” We must at least give him credit for coming clean.)

Perhaps the earliest warning sign, however, came from inside the halls of Merrill’s downtown Manhattan headquarters. In September 2006, demand for subprime bonds was going through the roof, even as delinquencies on the underlying mortgages were mounting. As Reuters points out, Kenneth Bruce, a Merrill equity analyst, warned his clients then that demand for the bonds “could dissipate quickly,” saddling companies with exposure to them with lower earnings.

If only he — and Stan O’Neal — knew how right he would prove to be.