It’s the bottomless write-downs! According
to William Tanona of Goldman Sachs, the write-downs we’ve
already seen at Citigroup and Merrill Lynch aren’t even close to being
final. Indeed, he reckons that both banks will see 11-figure
write-downs in the fourth quarter alone, over and above what they’ve
already taken.
Especially in the case of Merrill Lynch, this is very
serious money: the $11.5 billion write-down that Tanona now expects in
Q4 is equivalent to 37% of the bank’s book value, and is likely to
result in a single-quarter loss of $7
per share.
But if Tanona has managed to draw a bead on the magnitude
of Merrill’s upcoming losses, that means that the same question now
arises at Merrill that I
had about Morgan Stanley earlier this month.
Not only has Singapore’s Temasek bought
into Merrill to the tune of $4.4 billion, but US-based Davis
Selected Advisors is putting in $1.2 billion as well. So let’s try to
run through the different possibilities here.
- Temasek and Davis are investing $6.6 billion into Merrill
at $48 per share, but have no idea what Merrill’s Q4 loss is likely to
be. If it turns out to be enormous, they’ll be surprised, and they’ll
be very upset at John Thain for not warning them of the enormity of the
upcoming loss.
- Temasek and Davis have done their due diligence on Merrill,
and have been warned by Merrill that a large write-down is coming in
Q4: they’re walking into this announcement with their eyes open. In
fact, they understand that their capital injection is necessary for
Merrill to be able to take this write-down in the first place.
- Temasek and Davis have done their due diligence on Merrill,
and they know exactly what skeletons are located in its various
closets. To them, it’s largely immaterial whether and how Merrill marks
its CDO holdings on a quarterly basis, since they’re long-term
investors. If Merrill decides to take a large quarterly loss, they
might be surprised, but they won’t be upset, since it’s of no great
matter to them.
Of these, the first is highly improbable: Thain would never
treat a white-knight long-term shareholder in such a manner.
The second, I’m pretty sure, would constitute a breach of SEC
regulations. Not on the part of Temasek or Davis, but rather on the
part of Merrill. If Thain knows today that Merrill is going to take an
enormous 11-figure write-down in the fourth quarter, that’s material
information, which he needs to communicate to the markets in a timely
manner. (“Timely”, in this context, has a precise definition:
four days.) If he doesn’t communicate that information by the end of
the week, then one can assume that he doesn’t have it.
What we’re left with is a world in which the facts on the
balance sheet can be known, but the way they’re accounted for is
largely left to the discretion of the bank’s executives. Merrill has a
shedload of CDOs on its books and isn’t sure what to do about them?
Well, now that it’s got its capital injection, it can afford to take an
enormous write-off. On the other hand, it could just as easily get away
with not taking that write-off right now.
The last possibility is the most likely, but you’ll never find
a bank which will admit it’s the case. According to them, they conform
scrupulously with GAAP and all other reporting regulations, they have
little if any discretion over what their results will be in any given
quarter, and they certainly don’t have discretion
over whether or not to realize $11 billion in losses.
If Merrill reports a loss of more than a couple of bucks a
share in the fourth quarter, then, it’ll be very interesting to see
which of these options they say corresponds to how things actually
happened. Because none of them is something that Merrill would be very
happy admitting.