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Merrill Mired in Debt Mess

Shares fall ahead of Wednesday morning's big earnings report.

If it's possible, the sentiment on

Merrill Lynch


seems to be getting even more downbeat.

Shares in the New York brokerage house fell 2% on the eve of the firm's eagerly awaited third-quarter earnings report. The latest decline puts the stock 34% below its early-year high.

Merrill and its brokerage-industry brethren have been hit hard this year by a sharp turn in the debt markets. Earlier this month, Merrill said missteps on its fixed-income and risk-management desks would cost it a staggering $5.5 billion in third-quarter writedowns. That's the largest hit any Wall Street firm has taken since this summer's credit crunch ended the leveraged-buyout bull run of 2007.

But some observers believe more pain is ahead for Merrill chief Stan O'Neal. On Tuesday, Sanford Bernstein analysts projected that tightening the screws on Merrill's risk-management desk may cost about $1 billion in net income and about $1.10 in earnings per share for 2008.

Merrill is slated to report third-quarter earnings tomorrow morning. Analysts polled by Thomson Financial are forecasting a loss of 45 cents per share on revenue of $3.25 billion.

Analysts are expecting the firm to retrench its bond trading platform as a result of the poor performance.

"We certainly have seen Merrill take such actions before," Sanford analyst Brad Hintz writes. "David Komansky, the former chief executive officer of Merrill, cut back on trading after the firm's Long-Term Capital Management debacle in 1998."

Already the fallout at Merrill has claimed its victims. The firm broke ties with Dow Kim, its former head of co-trading and investment, who was about to launch a company-backed hedge fund. Merrill also has dismissed fixed-income head Osman Semerci, replacing him with David Sobotka.

Hintz expects, however, that Merrill could make a relatively quick recovery in if it succeeds in tidying its fixed-income operation. Bernstein rates Merrill outperform with a $100 price target. The stock fell $1.19 Tuesday to $65.28.

Big financial institutions have taken hits resulting from the tightening of the credit markets and increased volatility. Merrill,


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all took billion-dollar writeoffs in the last quarter, due to the turmoil in the mortgage, housing and credit markets.


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also took big hits, but observers believe that those firms may have better navigated the subprime mortgage mess.