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John Thain on the Fire Sale of Toxic Assets at Merrill


"It [is] almost impossible—not totally, but almost impossible—that we would ever have exposure on these loans"

Ever since he took charge at Merrill Lynch (MER) in November 2007, former New York Stock Exchange (NYX) chief John Thain has been struggling against enormous odds to revive the storied investment bank, badly battered by the global credit crisis. He's selling Merrill's stake in Bloomberg, and on July 28 he made his most radical move so far, unloading billions of dollars in toxic mortgage investments to the Dallas private equity firm Lone Star Funds for pennies on the dollar. I talked with Thain on Aug. 4.

MARIA BARTIROMO

You've made some extraordinary moves in the past week, selling more than $30 billion worth of CDOs [collateralized debt obligations] for the bargain price of $6.7 billion, or 22¢ on the dollar, compared with the 36¢ you valued the securities at just a quarter before. Why take this hit and do the sale immediately?

JOHN A. THAIN

This sale of CDOs is a huge move in reducing the risky assets on our balance sheet. It's a continuation of the process we've been going through for the past seven months, but it's most significant in that these assets and their related hedges represent approximately 70% of all the losses that we've taken over the past 12 months. And the ability to get this sale done in one bulk trade to a single buyer, where there has been almost no liquidity in this marketplace, made sense for us both to reduce risk and eliminate the overhang of continued losses from asset devaluations.

Explain this deal to me, because people still don't get it. They feel that you still have exposure here. If Merrill is financing 75% of the purchase price, and Lone Star can put the CDOs back to Merrill if they drop too much in value, don't you still have downside exposure? How has the bank's risk been reduced?

First, there's no put back to us whatsoever. Second, the financing is structured in a way that makes it extremely unlikely that we would ever have any exposure on these assets again. It is a true sale. And the paydown on the cash flows amortizes our loan in a way that makes it almost impossible—not totally, but almost impossible—that we would ever have exposure on these loans.

The International Herald Tribune reported that Lone Star has the right to put the CDOs back to Merrill. So you're saying that is wrong?

That is wrong.

Let me ask you about your credibility, John. I last spoke to you for BusinessWeek when you first took the Merrill CEO job in November of '07. At that time you said you saw 6 to 12 months of subprime pain ahead. What's your best guess now as to when this debacle will work its way through the system, and why did you say back in December that you weren't going to raise capital—indicating that Merrill had enough money and wouldn't need further cash infusions? What changed?

The simple answer is: The market changed. At the end of '07, we lost $8.6 billion for the year, and we raised $12.8 billion of new capital. So almost 50% more than we lost. By January we were well capitalized. Unfortunately, the world didn't stay the same. Asset values declined dramatically over the next six months. As asset prices declined, particularly mortgage-related assets, that created incremental losses and incremental needs for capital. Besides the decline in asset values, the changes included the demise of Bear Stearns, dramatic widening in credit spreads, and a tremendous lack of liquidity.

So will you stop saying you don't need to raise more capital?

No. I still have to answer the question as of a specific point in time. Today, with the transactions we did last week, we are well capitalized. If the world continues to deteriorate and asset values continue to decline, then in the future we may have to make different choices.

Is the dividend in jeopardy?

We evaluate the dividend every quarter. We believe that we will, in a short period of time, be able to earn and cover the dividend, but that is something that we always evaluate.

In an interview with Brad Hintz of Sanford C. Bernstein in March, you said Merrill intended to hold on to as many of the CDOs as possible and sell them off gradually as prices recovered. In this deal, isn't Merrill basically giving away any upside recovery?

We are giving away any upside recovery. We are selling 100%, so we're not anticipating any upside recovery. The biggest change is the impact on our 60,000 employees, who generate $7.5 billion in revenues, earn just under $2 billion pretax, and have all their efforts overwhelmed by write-offs coming from these assets. So we decided it was better for our company and shareholders to rid ourselves of these assets and go forward with our core business, which is wealth management, investment banking, and trading—not a hedge fund investing in illiquid assets.

Have there been any reverberations from your decision to value the CDOs at just 22¢ on the dollar? Have other bank CEOs called you to complain?

No one has specifically called me to complain. And remember, this is a bulk sale price of $30 billion. And also the first trade like that, because there has been almost no liquidity in the CDO market. I expect there will be follow-on trades.

So the Lehmans (LEH) and Citis (C) of the world will be right behind you?

I can't speak for anyone else, but all of the investment banks and commercial banks are shrinking balance sheets and reducing assets, and this is one of the most toxic of assets.

Is it fair to say the price is 22¢ on the dollar today?

I can only say that the price was 22¢ on the dollar to sell $30 billion worth to a single buyer in a single trade.

If there is a need at some point for further capital, would you consider selling the BlackRock (BLK) stake?

We have always said, from the first of the year, that we would evaluate all of our options and decide what was in the best long-term interest of our shareholders. We do view our BlackRock stake as a strategic asset, but we would always look to all of our alternatives.


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