In a quarterly dance routine that's becoming quite familiar -- call it the write-down, capital raising dance -- the Wall Street Journal reports that Merrill Lynch & Co. (NYSE: MER) is planning to sell a $5 billion stake in Bloomberg, the media company, and to cash out of its 49% stake, estimated at $12 billion, in Blackrock (NYSE: BLK).
Why is Merrill doing this? As we've seen over and over again in the last year, banks must maintain specific levels of capital to assets in order to meet regulatory requirements. When a bank reduces the value of its assets, as accounting rules require, the bank writes off the decline in asset values against its capital. In order to maintain a sufficiently high ratio of capital to assets, banks seek to raise capital equal to the amount of the write-down.
Merrill anticipates taking $6 billion in write-downs for the quarter. These could come from its $41 billion in Level 3 assets -- assets valued based on computer models since there is no active market that prices them. Merrill is fortunate to have these stakes available to sell because it will be able to raise capital without diluting current shareholders. Unfortunately, once it sells these stakes, Merrill shareholders will no longer get the earnings stream they generated.
The key thing for bank investors is that this write-down, capital raising dance shows no signs of slowing down. The question is this: Can the sources of new capital exceed the amount of the write-downs? I hope, for the sake of the banking system, that the answer is yes. If not, taxpayers will end up paying more of the bill.
Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter. He has no financial interest in the securities mentioned.
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