Merrill sparks fears bank crisis costs to soar

By Steve Slater and Jonathan Stempel - Analysis

LONDON/NEW YORK (Reuters) - Merrill Lynch & Co's surprise write-down ratchets up pressure on rivals to cut the values of their own subprime assets as they grapple with mounting debts and economies weaken.

The global credit crisis, roughly a year under way, could cause total damage of around $1 trillion to balance sheets of financial services companies. That's far above the more than $400 billion of write-downs taken so far.

Merrill's revelation of a $5.7 billion write-down and plans to sell $8.5 billion of stock heightened worry of more pain to come from European lenders UBS AG and Barclays Plc, and from Wall Street and U.S. commercial banks.

Citigroup Inc, Bank of America Corp, Lehman Brothers Holdings Inc and Wachovia Corp, for example, each still have billions of dollars of exposure to complex debt, mortgages, or both.

About $4.4 billion of the Merrill write-down came from a sale of $30.6 billion of collateralized debt obligations -- which are typically backed by mortgages -- to private equity firm Lone Star Funds for $6.7 billion, or 22 cents on the dollar. Merrill had valued the CDOs at $11.1 billion just four weeks ago.

"It was a very aggressive markdown," said Chris Henson, a portfolio manager at MFC Global Investment Management in Toronto. "The question is, is that now the clearing price for anyone who has CDOs?"

Prospects of more write-offs and credit losses have already battered lenders' shares. The Standard & Poor's Financials Index, for example, had through Monday fallen 32 percent this year, twice the S&P 500's decline.

"The current environment is not one where people are prepared to give the benefit of the doubt," said Gerry Rawcliffe, group credit officer for financial institutions at Fitch Ratings. "There's a broad loss of confidence in banks."

Merrill's sale may also offer insight into the value of rivals' so-called Level 2 and Level 3 assets. Banks value these based on prices of similar securities in the marketplace, or on their own models when there is no market for them.

"Other buyers out there are going to use this as a reference point," said Michael Hampden-Turner, a Citigroup credit strategist. "The question is, to what extent does 22 cents constitute fair value, or the price at which a bank could offload a huge volume of very distressed assets?"

TOUGH TO VALUE

It remains difficult for outsiders to assess the quality of assets on balance sheets. Some banks, such as Barclays, claim their assets are better-quality and more well-hedged.

Citigroup said it ended June with $22.5 billion of subprime exposure. That included $18.1 billion of super-senior asset-backed securities CDOs (ABS CDOs), the kind of debt Merrill sold, including $14.4 billion of commercial paper.

Deutsche Bank Securities Inc analyst Mike Mayo said Citigroup might face an $8 billion write-down on CDOs, as the bank has valued them at 53 cents on the dollar. Fox-Pitt Kelton analyst David Trone estimated a $4 billion write-down.

Citigroup spokeswoman Shannon Bell declined to comment. On July 18, Chief Financial Officer Gary Crittenden said: "There has not been a single American dollar cash flow loss against the asset-backed commercial paper ... I rush to add that that is not a forecast for the future."