Introduction

Yesterdays, shocking announcement by Merrill Lynch of $8.4 billion dollars deserves scrutiny. That is, this loss represented about 20% of Merrill’s net worth, and led to further stock decline. Merrill’s stock has declined in the last 12 months from a high of $98 to about $60. Moreover, most analysts remain neutral on Merrill stock, because given the large amount of Collateralized Debt, Leveraged Loans, and Mortgage-Backed Securities on Merrill’s balance sheet, another $5 billion write down is a reasonable guestimate. The rating agencies have downgraded Merrill’s debt to A+ but left the company on “further negative watch.” Since Merrill is a huge borrower in the capital markets, this lower debt rating will increase significantly their interest costs on new borrowings. The bottom line is Merrill Lynch shareholders and the general public better off with the “new” Merrill with its riskier profile? So far, the jury is still deliberating. Since I am not a shareholder, my vote is that Mr. O’Neal walks the plank! His legacy of promoting “yes men” and purging perceived competitors deserves similar justice.

In essence, Stan O’Neal represents some of the most unsavory features of today’s financial community. That is, he orchestrated a dramatic ramping up of Merrill’s risk profile. While these actions for several years increased Merrill’s annual earnings from the $2 Billion range to the $5 Billion range, yesterday’s loss undermined much of that supposed progress. In essence, in one fell swoop, Merrill lost about 1.5 years of earnings. Moreover, Merrill still has a wobbly balance sheet that needs more pruning.

Mr. O’Neal and his “Big Swinging Dicks” colleagues made enormous bonuses for taking these outsized risks. Mr. O’ Neal made $51 million dollars last year, and other Merrill executives reaped big rewards. The risk was to the shareholders, the rewards were to Mr. O’Neal and his hand chosen henchmen.

On the positive side, Mr. O’Neal did make a brilliant acquisition of Black Rock, a first-tier institutional money manager and did upgrade the reputation of Merrill’s trading and investment banking teams. However, Mr. O’Neal’s decision to now reduce Merrill’s trading presence could lead to an exodus of his better traders.

Background

Since Mr. O’Neal’s ascension to Chief Executive in 2002, Stan O’Neal has sought to change totally the Merrill Lynch culture. Mr. O’ Neal, a self-made Black executive, had no tolerance for the Waspish culture of Merrill Lynch that he inherited.

For years, Merrill had been noted as a first-rate brokerage firm that depended upon their huge retail network of salesmen to generate commission income. Moreover, Merrill leveraged their retail network to attain a top spot in underwriting investment banking rankings, and built up their retain asset management business. To eliminate the image of “Mother Merrill,” O’Neal has purged many Merrill old liners who had a laid-back style. In essence, O’Neal did not tolerate the prevalent Merrill philosophy of “To move along, you must get along.” Instead, he brought in tough, young risk takers who had the personality characteristics of Goldman Sachs, Lehman Brothers, and Bear Stearns.

While I never worked for Merrill during my thirty-five-year Wall Street career, recognizing that my personality profile would keep me stifled somewhere in middle management, I did appreciate the gentlemanly quality of my Merrill Lynch peers. They might not have been the “sharpest sticks” in the tool box, but they also were not Attila the Hun.

However, Mr. O’Neal understood fully that for Merrill Lynch to significantly increase their return on assets, they needed to eliminate their “agency” culture and focus significantly more heavily on proprietary trading. Moreover, he wanted Merrill to compete globally to increase their share of merger and acquisition activity, and their institutional asset management business. In order to increase their merger and acquisition activity, Merrill not only needed to attract a higher quality level of investment bankers, but needed to risk more capital by making “risky” bridge loans to finance acquisitions. That is, the private-equity firms that represented some 30% of all mergers wanted financial muscle to supplement “brain” power.

Mr. O’Neal in essence decided to augment Merrill’s service income with trading profits from greater exposure to hedge fund activity, proprietary trading, and risky loans.

Future

In today’s global financial environment, Stan O’Neal tried to upgrade Merrill to worldwide major league status without merging with a large capitalized commercial bank. Yesterday’s loss undermines much of the progress Merrill made during O’Neal’s ruthless regime. That is, the terms “Mack the Knife” and “Chainsaw Al” certainly fit O’Neal’s profile. In the long run, companies grow by developing a spirit de corps from training and promoting from within. O’Neal in his “rush to justice” seemed to have lynched more than a few innocent more conservative risk managers who saw Red on the horizon.

Originally published in the Sarasota Herald-Tribune