Avoid Merrill Lynch and other subprime lender stocks

More than 110 mortgage companies, many of them subprime lenders, have closed, filed for bankruptcy or put themselves up for sale since the start of 2006. Investors are refusing to buy bonds backed by subprime loans. You all heard by now about Merrill Lynch's (NYSE:MER) $7.9 billon writedown, friends, it's all about to hit the fan.

Merrill's stock is the third-worst performer in 2007 among securities firms after E*Trade Financial (ETFC), which had home-loan losses at its online bank, and Bear Stearns, where two hedge funds lost $1.6 billion of clients' money. Merrill is down 21 percent this year through Monday. In contrast, Goldman Sachs has gained 15 percent and Morgan Stanley is down 2.2 percent. Just look at the fall from greatness, from $90+ to $60 a share, it's pitiful:

Not since Russia defaulted on its debt and the collapse of hedge fund Long-Term Capital Management in 1998 have the credit markets suffered so many dislocations. The world's largest financial institutions have written down more than $21 billion of mortgages, securities and corporate loans whose value plummeted during the third quarter.

Merrill's now ex-CEO Stan O'Neal bought subprime mortgage lender First Franklin Corp. for $1.3 billion in December, just as the real- estate market peaked. Stan is the guy next to Grover and Elmo, notice how natural he fits in with those other muppets, puppet boy indeed.

Stan announced an $8.4 billion writedown Oct. 24 on loans and bonds backed by home loans, almost double Merrill's estimate on Oct. 5. Maybe Grover can help you understand 'Near' and 'Far' better Stan, you'll get it right at your next job.

The firm may have to cut the value of its holdings by $4 billion in the fourth quarter, on top of the $8.4 billion charge, which included costs for loans to finance leveraged buyouts, according to CIBC World Markets.

Merrill was downgraded on Oct. 25 by four analysts who said the value of the firm's subprime mortgage assets will probably erode further. Goldman Sachs Group Inc., UBS AG, Wachovia Corp. and Sanford C. Bernstein & Co. analysts cut their recommendations from the equivalent of buy to hold.

The Masters are holding out for Merrill Lynch's stock to fall below $60 a share and we think it's just a few weeks away. We all know this industry will comeback, its just going to take time, so watch for the big buyer moves and keep you eye out for entry points. Even evil Countrywide (NYSE:CFC) which jumped 30 percent since last Thursday will keep getting hit hard by critics of the subprime disaster.  Stay on the sidelines on Countrywide, WaMu (NYSE:MU), and Merrill, but push come to shove, Merrill Lynch is ten times the company the other horrible subprime lenders are.  Since 1971, Merrill Lynch has increased revenues at an 11% compound annual rate. Merrill Lynch owns approximately half of BlackRock, one of the world's largest publicly traded investment management companies, with more than $1 trillion in assets under management.

Just like everyone on Wall Street, we expect to see Muppet boy Stan O'Neal out by the end of the week, then we can all look at MER shares again for the value play.

 

Fellow Masters, my articles and stock recommendations are soon to be available on WallStNewsletters.com.  I look for undervalued securities and the cheaper the price the better.  OTC stocks are my favorite hunting grounds and I never pull the trigger on a stock that costs more than $5 and is worth holding for at least 3 to 6 months.  Note that all my stocks are currently showing a positive return and I'm at an average 31% return YTD.  Click here to learn more about Reeves and his previous and upcoming publications.

Steve Reeves - Coming soon to WallStNewsletters.com and the next member of the Full Monte