Writedown Talk Whipsaws Citi

Updated from 1 p.m. EDT

Another round of writedown talk sent brokerage stocks reeling for a second straight day Friday.

Merrill Lynch ( MER) plunged as much as 11% on news reports that the firm faces regulatory scrutiny over its handling of potential losses on mortgage-backed securities. The news, along with the latest downgrade from Deutsche Bank analyst Mike Mayo, sent shares down 3% and more across the brokerage sector.

Mayo said Merrill and Citigroup ( C) could together take $8 billion in further mortgage-related writedowns in the fourth quarter. Merrill shares have been sinking ever since last month's disclosure that the firm would have to take billions of dollars in writedowns on its holdings of collateralized debt obligations, the esoteric debt whose collapse has left financial firms across the world wallowing in losses.

Also Friday, Goldman Sachs ( GS) tumbled 6% on unconfirmed rumors that the firm faces a big writedown of its own. Goldman said the rumors are "untrue," but the notion that the big firm is under scrutiny unnerved investors. Goldman shares had been the standout in the brokerage group, hitting a 52-week high on Halloween as investors celebrated the firm's achievement in posting record third-quarter results back in September.

But the good cheer evaporated Friday, as firms across Wall Street shared in the pain of renewed stock-market declines. Bear Stearns ( BSC), Morgan Stanley ( MS), Lehman Brothers ( LEH), JPMorgan Chase ( JPM) and Citigroup each dropped between 3% and 4%.

The selloff has renewed pressure on CEOs whose firms have incurred steep losses as a result of this summer's credit crunch and mortgage industry deterioration.

Aside from Merrill Lynch, which ousted CEO Stan O'Neal earlier this week, investors have also been calling for the resignation of Citi chief Chuck Prince and Bear Stearns CEO Jimmy Cayne. His firm took a beating after it declared two of its hedge funds worthless this summer from the subprime mortgage meltdown.

Mayo made his writedown predictions in an industry note in which he said that the brokers and large banks would be required to take a total of $10 billion of writedowns from collateralized debt obligations and other mortgage-backed securities in the remaining quarter of the year.

Mayo expects the remaining $2 billion to be split among Bear Stearns, Morgan Stanley, Bank of America ( BSC) and Wachovia ( WB ).

He downgraded Merrill Lynch to hold from buy on Friday.

"Our concern is on relying on a company's statements that has no CEO and is facing a potential SEC investigation and may have engaged in questionable private transactions," Mayo wrote in a note to clients.

Merrill issued a release at midday that resulted in a modest pullback from the stock's lowest levels.

The Journal's article was "nonspecific and relies on unidentified sources," Merrill Lynch said in a statement. "We have no reason to believe that any such inappropriate transactions occurred. Such transactions would clearly violate Merrill Lynch policy."

Even so, Mayo indicated earlier, questions remain.

"We have increasingly lost confidence in the financials of Merrill, especially after the sudden increase in CDO writedowns from the three weeks after its 3Q07 preannouncement and the high level of information risk which, while alarming, was bearable with the reduced exposure," Mayo continued. "If there are much higher CDO writedowns, Merrill may have additional credit rating downgrades and may need to find a partner to give it new credibility and financial strength."

Mayo also cut earnings estimates for the second time this week on Citi by 22 cents to 75 cents for the fourth quarter and by 20 cents to $4.05 for 2008 as a result of the CDO writedowns and its exposure to structured investment vehicles.

Analysts on average expect Citi to earn $1.02, according to Thomson Financial.

"We believe there could be additional pressure on CDO valuations (including the 2007 vintages) and a charge similar to the 3Q07 level is likely," Mayo wrote in a third note. "In addition, we believe that Citi may incur a loss on the SIV assets that are not eligible for the proposed Super SIV Structure." He reiterated his sell rating.

Mayo's concerns about capital echoed those of CIBC analyst Meredith Whitney, who cut Citi to sell Thursday, arguing the bank is undercapitalized. Citi fell 4% Friday after a 7% plunge Thursday. Citi declined to comment.

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