Business

LYNCH PINNED

The breathtaking third-quarter loss that Merrill Lynch reported yesterday due to its problematic portfolio of loans and securities isn’t likely to be the final chapter in what is proving to be a painful autumn for both the Wall Street giant and its CEO Stan O’Neal.

While O’Neal accepted responsibility for the $8.4 billion write-down that led to a $2.23 billion quarterly loss – Merrill’s first since 2001 – the bloodshed already seen, along with the expectation of more coming in the fourth quarter, has led to rampant speculation that darker days are in store for both the firm and its leader.

“The bottom line is . . . I got it wrong by being overexposed to subprime, and we suffered as a result of impaired liquidity,” O’Neal told analysts during a conference call yesterday.

Merrill’s stock dropped $3.90, a 5.8 percent decline to $63.22, a new low for the year.

The erasure of more than $3.47 billion in market capitalization is the least of the firm’s woes, however.

Standard and Poor’s was the first rating agency to take out the long knives as it shaved its debt rating to A+ from AA-, and kept the firm on “negative outlook.”

Even more eye-catching was the language that the usually circumspect ratings analysts used in describing their moves.

Leslie Bright, senior bank analyst at Fitch, told The Street.com, “We see some risk-management issues that have to be addressed that are above and beyond the third quarter.”

S&P’s Scott Prinzen called Merrill’s woes “startling,” blaming the losses on “management miscues.” He called the scope of the losses “staggering.”

Merrill had tried to brace Wall Street for the worst earlier this month when it issued a warning that it would book up to $5.5 billion in subprime write-downs, but that number turned out to fall far short of the actual $7.9 billion in losses related to its massive inventory of mortgage- and asset-backed securities and collateralized debt obligations.

In a late afternoon internal conference call, O’Neal attempted to hit some soothing notes to his stunned colleagues.

He described the original $5.5 billion estimate as having been accurate at the time, which was affected as markets continued to deteriorate over the past two weeks.

O’Neal downplayed the impact of the $8.4 billion loss, telling employees that in the context of a $1 trillion balance sheet, the effect from the write-down and loss was minimal. He also emphasized that other businesses, such as equity underwriting and advisory work, were doing fine.

But the bad news at Merrill is likely to continue well into the fourth quarter. That’s because recently, the structured product markets where Merrill has dominated trading and underwriting for the better part of a decade are actively collapsing.

What’s worse, at least $15 billion, according to Merrill management, is still on the firm’s balance sheet.

Since the beginning of the month, a variety of asset-backed securities indexes that track the value of bonds that are the key collateral in CDOs have dropped sharply in value. For example, the ABX AA-07-02 index was at 71 on Tuesday, down from around 88 on Oct. 1.

That means the fourth quarter is shaping up to be an absolute doozy for Merrill, as a major source of revenue racks up losses and begins to weigh on the bank’s balance sheet.

One disclosure that bodes ill for Merrill in the fourth quarter was its write-off of $100 million from its ill-fated acquisition of subprime mortgage lender First Franklin.

The firm paid $1.3 billion for First Franklin last September, including nearly $1 billion worth of goodwill.

According to Bloomberg, First Franklin – which was expected to bring in $700 million in annual revenues – has not only stopped doing subprime lending, but is not doing much conventional lending, either.

roddy.boyd@nypost.com