Despite writing off $8.4 billion of subprime mortgages, structured bonds and loans in the third quarter, Merrill's failure to detail how it has reduced its exposures - combined with the big swing in loss estimates in a period of just over two weeks - prompted several analysts to forecast further write-downs in the brokerage giant's fourth quarter, with some estimates topping $4 billion.
The situation highlights not only the Street's concerns about Merrill, which built a huge business repackaging mortgage loans and related securities that blew up under the pressure of the credit crisis that started this summer, but also other banks that essentially must be trusted to accurately value securities for which there is no active market.
''My skepticism is not related to Merrill Lynch. It extends to the whole industry,'' Punk Ziegel analyst Richard Bove wrote in a note Thursday. ''It is based on a belief that the firms lack the tools to value their holdings.''
Merrill's shares were down 4.8 percent at $60.20 in early afternoon trading Thursday.
The firm said Wednesday it reduced its inventory of collateralized debt obligations, or CDOs, to $15.2 billion at the end of September from $32.1 billion three months earlier, while shaving exposure to subprime mortgages 35 percent to $5.7 billion. In the process, the bank wrote down the value of its positions in those areas by $7.9 billion - a hit 75 percent bigger than the one the bank forecast in a profit warning Oct. 5.
On a conference call Wednesday, analysts pressed Chief Executive Stanley O'Neal and Chief Financial Officer Jeff Edwards about the change in loss estimates and whether the firm actually sold the rapidly declining assets or simply tried to hedge them. But the executives wouldn't give detailed answers.
''The biggest mystery to us is what happened to $11 billion in CDO exposure,'' CIBC World Markets analyst Meredith Whitney wrote in a note to clients, referring to the portion of the second-quarter total that was neither written down nor still on Merrill's books.
Merrill may be forced to mark the value of its remaining CDOs down by another $4 billion this quarter to reflect an eroding market, Whitney said. She forecast a loss of 50 cents a share for Merrill in the fourth quarter, and lowered her estimate for 2008 by 5 percent to $7.15 a share.
At Goldman Sachs, analyst William Tanona is assuming another $4.5 billion of write-downs on the firm's remaining $20.9 billion of CDOs and subprime mortgages in the fourth quarter, citing a severe deterioration in the value of asset-backed securities in the last week and a half.
Goldman removed Merrill from its ''buy'' list of top stock picks in the Americas, citing the stock's 23.6 percent decline since joining the recommended list on April 2. Tanona forecast a fourth-quarter operating loss of 44 cents a share, cut his recommendation on the stock to ''neutral'' from ''buy'' and reduced his price target to $79 from $92.
As a matter of policy, Merrill doesn't discuss analysts' forecasts, a spokeswoman said.
Only 10 days before announcing the $8.4 billion write-down, Merrill had said the loss would be closer to $5 billion. Deutsche Bank Securities analyst Michael Mayo asked O'Neal on a conference call Wednesday what changed so quickly and what it says about the firm's risk-management capabilities.
O'Neal gave little comfort about Merrill's valuations. The additional write-downs, he said, were the result of the firm's adopting more conservative assumptions. The revised $8 billion-plus estimate was ''still within the same range'' of the models used by the firm, he said.
