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Merrill's Debt Deal Not So Cut and Dry

Marek Fuchs

Take Forbes, for example. In a favorable article that ran yesterday called "Merrill Turns Its Luck Around," Forbes referred to the announced deal to sell billions in collateralized debt obligations to an investment fund based in Texas as a plan that "would reduce its exposure to collateralized debt obligations by $11.1 billion."

The next line reads "but that's not all," so The Business Press Maven naturally assumed Forbes would describe the specifics of the sale, which makes it way less than meets the eye.

These securities, after all, were valued at $11.1 billion a few weeks ago when Merrill reported its quarter results and are now being sold for $6.7 billion -- but that's not even the troubling part. See, the buyer would take the bucket of slop only if Merrill financed most of it. The company did -- 75% worth -- with debt whose only collateral are the assets that Merrill is selling. What does this mean in plain English?

Merrill is still open to tons of risk.

The company really only took out 25% of $6.7 billion, or $1.675 billion of risk, off the balance sheet.

In fairness, the Forbes article did refer to a previous piece that sported a headline about Merrill's changed fortunes. That one, which published the previous day, was called "Merrill Moves To Shore Up Books," and so The Business Press Maven naturally assumed that Forbes had at least laid out the gory details of the transaction in that article.

Did it? Nope.

This is what Forbes told us: "The sale price was $6.7 billion. But that wipes away $11 billion of exposure to the toxic investments."

And, as happens when you don't let your foot get caught on the details of a deal, a false conclusion came next, set out happily in the very next line:

"John Thain, Merrill's chief executive officer, appears to be doing everything he can to wipe the slate clean for the company."

Yes, he's wiping the slate clean ... by financing the sale of the bucket of slop and keeping much of the risk.

While Forbes really struck out on behalf of investors, others -- like The New York Times -- at least touched upon the technicalities of the financing but failed to explain what it meant.

The Times dipped its toe on the basic fact of the financing: "Merrill provided 75 percent financing to Lone Star Funds, which means Merrill lent the private equity fund about $5 billion to complete the sale." And that was it. It still referred to the company's "purge" of "tricky mortgage-linked investments" which are even trickier when you appear to sell them but are still absorbing risk.

The Times, though, did not get it, instead concluding that Merrill could go on its merry way now:

"But the sale of the C.D.O.'s, to an investment fund based in Dallas, may enable Merrill to move on, investors said.

"'What they sold, from a headline standpoint, is certainly constructive because they have reduced risk in a very sensitive area,' said Thomas C. Priore, chief executive of Institutional Credit Partners, a $12 billion hedge fund and C.D.O. manager in New York."

Well, yeah, business media, Merrill reduced risk. But not by much.