Credit Agricole And Merrill Lynch (MER): Two Blind Men, Same Elephant

May 13, 2008 by Douglas A. McIntyre

Credit Agricole may have to raise over $9 billion to rebuild its capital after substantial mortgage-related losses in the last quarter. According to The Wall Street Journal "Crédit Agricole said it will launch an action plan to refocus the corporate and investment banking division on its core activities and to reduce risk." The plan may be a little late, but management had to say something other than it will be business as usual in the future.

If the news from Credit Agricole has any broader implication, it is that the write-downs from large banks and brokerages are far from over. With $9 billion additional dollars, the French bank is not just making up for past losses, it is getting dry powder for future ones.

Oppenheimer made the comment yesterday that Citigroup could not be fixed by anyone living on the planet today or any aliens available from outer space. The big conglomerate is too broken and may not have any meaningful earnings for five years. That would not go into the inbox marked "good news".

During all of this trouble, Merrill Lynch is telling every person they can find, including those who don’t know a balance sheet from a bagel, that the brokerage is fine and will not have to raise any more money. The two top Merrill financial executives told a conference that "We’re very, very comfortable with the balance sheet that we have and, more importantly, the credit quality that’s on the balance sheet." Yes, very, very.

Not everyone can be right because they do not live in parallel universes. In this one year and in 2009, the housing mess will either take a much sharper turn down or it will find a bottom. LBO debt will improve in value because corporate earnings and the economy are improving or junk level debt will continue to hit record levels of defaults. The two sets of opposing views cannot be right at the same moment.

Merrill may want to look to its share price for the answer of how believable its management is. Over the last three months, it has underperformed the Dow and perhaps its most direct competitor, Morgan Stanley (MS).

Whistling past the graveyard may make the people inside the Merrill Lynch building feel better, but the management there runs the risk of looking like Credit Agricole did today. The French bank said things were worse than they expected. And, they did not say that was expected that to change.

Douglas A. McIntyre