Merrill Lynch & Co, Washington Mutual Inc and Sovereign Bancorp Inc on Friday became the latest banks to take big writedowns on mortgages and other credit-related losses, but their shares rose on hopes the worst was over.
Following similar warnings earlier this week from Citigroup Inc, UBS and Deutsche Bank, the latest disclosures dramatized the sweeping impact of the meltdown in the subprime mortgage market and left investors wondering how many profit warnings were still to come.
The share gains echoed a similar rally in Citi stock on Monday after the largest US bank's own multibillion-dollar writedown.
"The market I think has pretty much signaled that coming clean and taking your lumps is the best thing you can do for your stock price, as long as the lump doesn't put you out of business," said Bill Hackney, a managing partner at Atlanta Capital Management.
Merrill shares were 3.1 percent higher at US$77.12 in afternoon trade, while Wamu stock rose 2.7 percent to US$36.23. Sovereign trimmed gains after its profit warning but was still up 2.2 percent.
Merrill said it would write down US$5.5 billion for bad bets on subprime mortgages and leveraged loans, taking the worst hit yet among major Wall Street brokerages from turmoil in the credit markets.
The bulk of the losses will come from marking down the value of complex instruments known as collateralized debt obligations (CDOs), and from declines in subprime mortgages -- loans given to customers with poor credit history.
Financial analysts and credit rating agencies agreed the unexpectedly large writedown would hurt Merrill Lynch's image and call into question its ability to manage risk.
"We believe that the magnitude of [Merrill Lynch's] losses might dampen the firm's reputation around acquisitions," Wachovia Capital Markets LLC analyst Douglas Sipkin wrote in a research note.
In total, Merrill said it would report a loss of up to US$0.50 per share for the quarter.
Analysts polled by Thomson Financial on average forecast earnings of US$1.24 per share for the quarter ending on Sept. 30.
About US$4.5 billion of the writedowns are related to the declining value of subprime mortgages and CDOs. Merrill Lynch said it took significant steps to reduce its exposure to the subprime market in the third quarter.
The warning came on the heels of an executive shakeup at the bank, which blundered by spending US$1.3 billion to buy subprime mortgage lender First Franklin Financial last December, just before the market for home loans to buyers with weak credit histories went into free-fall.
Wamu, the No. 1 US savings & loan, said it expected a 75 percent plunge in profit after provisioning nearly US$1 billion for loan losses and taking US$410 million in losses and writedowns for various loans and securities in its portfolio.
Sovereign, the second-largest thrift, roughly tripled its provision for credit losses sequentially to US$155 million and US$165 million and said it would take US$35 million in charges related to financings extended to troubled mortgage lenders as well as writedowns of loans in its portfolio.
Both Merrill and Wamu sought to portray the losses as a one-off hit and said they were hoping for a fourth-quarter turnaround.
"While we're disappointed with our anticipated third-quarter results, we look forward to an improved fourth quarter as we continue to see good operating performance in our retail banking, card services and commercial group businesses," Wamu chief executive Kerry Killinger said in a statement.
Merrill Lynch CEO Stan O'Neal was similarly reassuring.
"While it is very early in the current quarter and despite continued challenges in structured finance, we are beginning to see signs of a return to more normal activity levels in a number of markets," he said.
But many believe the writeoffs will continue.
"Although they may firmly believe this gets everything out of the way, I think there's going to be further reserve additions in future quarters," said Keith Davis, an analyst at fund manager Farr, Miller & Washington. "I'm pretty bearish on the whole banking sector."
Citi, Merrill and Wamu were three banks in the spotlight coming into the third quarter because of their exposure to CDOs, leveraged loans and subprime mortgages.
Now they have made a clean breast of their losses, investors are betting they will soon have company.
JPMorgan Chase and, to a lesser extent, Bank of America and Wachovia Corp may take hits as well.
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