Will a fire sale at Merrill Lynch & Co. force similar moves by other investment banks?
That was the big question Tuesday on Wall Street after Merrill's surprise decision to dump a huge chunk of troubled mortgage bonds for pennies on the dollar.
Merrill Chief Executive John Thain said late Monday that the brokerage would sell so-called collateralized debt obligations once valued at $30.6 billion for 22 cents on the dollar.
Analysts generally applauded the move, saying that clearing away the residue of the subprime mortgage bust was essential for Merrill to get its business back to normal.
The move also could help the economy. Some financial industry critics say that the longer banks and brokerages take to get past the subprime crisis, the greater the risk that they'll plunge the economy into a prolonged downturn like the one that wracked Japan in the 1990s.
But blue-light specials for troubled assets can mean a lot more pain for shareholders. Merrill had to write off $5.7 billion -- bringing its total subprime write-offs over the last year to almost $52 billion.
To bolster withered capital, the company also issued $8.6 billion of stock Monday, diluting existing shareholders by a whopping 38%.
The company's shares dived 12% on Monday to a 10-year low before the announcement. The stock opened lower Tuesday but rebounded with the rest of the financial sector to close at $26.25, up $1.92, or 7.9%.
Merrill's move could put pressure on Citigroup Inc. in particular, several analysts wrote in notes to clients Tuesday.
Citigroup still has $22.5 billion of subprime assets, the largest of any investment bank, according to Meredith Whitney, an analyst at Oppenheimer & Co. UBS is next at $15.6 billion.
What's more, Citigroup values its subprime portfolio at 55 cents on the dollar, says William Tanona, an analyst at Goldman, Sachs & Co.
"We continue to believe they would struggle to obtain their prices in the marketplace today," Tanona wrote.
Some analysts doubted Citigroup would match Merrill's 22-cent valuation because Citi has long maintained that many of its mortgage holdings were originated before the excesses of the subprime crisis took hold.
Nevertheless, Citi might have to write off $8 billion this quarter, which could force it to raise more capital, according to Michael Mayo, a Deutsche Bank analyst. "The decision about raising new capital could be closer than we previously thought," Mayo wrote.
Still, Citi's shares rallied Tuesday, climbing $1.02, or 5.9%, to $18.45.
Money & Co.
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