Merrill shares fall as credibility questioned

By Tim McLaughlin

NEW YORK (Reuters) - Merrill Lynch & Co Inc's credibility is coming under increased attack after an analyst said the biggest brokerage sought to mitigate write-downs by parking subprime-related assets with hedge funds.

Shares of Merrill MER.N, which ousted Chief Executive Stan O'Neal earlier this week, sank to a two-year low on Friday, falling 9.3 percent to $56.44 in trading on the New York Stock Exchange. Shares are down 38 percent this year.

Friday's decline came after the Wall Street Journal reported that the brokerage may have used deals with hedge funds to delay losses on billions of dollars in troubled assets.

Scott Berman, a hedge fund lawyer for Friedman Kaplan Seiler & Adelman, said the purpose of such a move would be to clean up a company's balance sheet. He said he is not aware of any transaction involving Merrill.

"I don't know whether it is legal, but it certainly smells fishy," Berman said. "If I were a Merrill shareholder, I wouldn't be happy about it."

Merrill was not available for comment.

Janet Tavakoli, a structured finance analyst, said in a note last week that Merrill had asked hedge funds to take its troubled assets for a year in an off-balance sheet credit facility. The effect of such a deal would reduce Merrill exposure to collateralized debt obligations, but only temporarily.

"One fund claimed that Merrill was offering a floor return (set buy-back price), so this risk would return to Merrill," Tavakoli said in her note. "That would explain the magnitude of the exposure disappearance, but only if Merrill was able to find counterparties."

Merrill shocked investors last week when it took an $8.4 billion write-down in the third quarter. The company's $2.3 billion loss -- the largest quarterly loss in its history -- was several times bigger than what O'Neal forecast in early October.

Most of the write-down was from Merrill's exposure to CDOs, or pools of loans that have ties to subprime mortgages.

Analysts expect further CDO write-downs this quarter because Merrill's still carries $15.2 billion worth of exposure to these securities. Its exposure to U.S. subprime-related mortgages is $5.7 billion. Some analysts estimate another write-down of up to $5 billion will happen this quarter.

In July, as turmoil ripped through the global credit markets, analysts and investors began pressing Merrill for more detail about its CDO exposure. Merrill's pointman for those questions has been Chief Financial Officer Jeff Edwards.

Edwards, who was an investment banker before becoming CFO, declined to give any specific figures on Merrill's CDO exposure, but assured analysts and reporters the company had effective and aggressive risk management in place.

"Risk management, hedging, and cost controls in this business are especially critical during such periods of difficulty, and ours have proven to be effective in mitigating the impact on our results," he said on a conference call in July.

When further pressed about CDO exposure, Edwards said the company had significantly reduced exposure to lower rated segments of the CDO market.

"And I think the majority of our exposure continues to be now in the highest credit segment of the market," Edwards said on the July call. He added that Merrill's CDO business was only part of a larger fixed-income operation.