Kitchen-sinking the losses at Merrill

Kitchen-sinking the losses at Merrill

Another day, another sovereign wealth fund lands on Wall Street. The recipient this time around is Merrill Lynch and Co. Inc. And its benefactor is the government of Singapore, which operates two funds that have already helped bolster the capital positions at UBS and Barclays Bank Plc and taken a stake in Standard Chartered Bank.

This suggests Merrill’s new boss John Thain won’t hold back in kitchen-sinking the Thundering Herd’s losses in the fourth quarter. The bank took $8.4 billion (Rs33,264 crore) in third-quarter charges related to subprime securities and collateralized debt obligations—twice its original estimate—and ushered out Thain’s predecessor, Stan O’Neal.

Now it looks set to torch a similar amount. If the firm marks its inventory of structured finance along the lines that rival Morgan Stanley did earlier this week, Merrill will need to slice another $7.6 billion from its estimate of the value of its holdings, according to Credit Suisse. Added to this would be another half a billion dollars to account for declines in the value of its leveraged loan commitments.

For Thain, marking down Merrill’s holdings at least as aggressively as Morgan Stanley looks like a no-brainer. It would give him a clean palette from which to paint his recovery landscape. His primary constraint is capital. Slicing $8 billion from Merrill’s coffers could potentially make it the weakest of the Wall Street bunch.

In the third quarter, Merrill was in compliance with regulatory requirements that it maintain capital equivalent to no less than 10% of risk weighted assets. Another $8 billion hit and Merrill might not have had enough capital. Without an infusion, its ratio of tangible equity to assets would have been the lowest of its peers—even lower than dowdy Bear Stearns Cos.

Now, Merrill has options for raising money. It could, for example, cut its dividend. Alternatively, it could sell its 20% stake in Bloomberg Lp. But doing so in a hurry would almost certainly erode much of its value, something mayor Mike Bloomberg may be anticipating—he just put a new boss in charge at the firm.

Enter the Singaporeans with their emergency funding. Assuming it comes on terms similar to those offered by Citigroup, Morgan Stanley, UBS and others when welcoming sovereign wealth funds, the price will be high but not crippling. That should free Thain to throw everything but the kitchen sink into a disastrous fourth quarter.