Merrill Lynch Unscathed, So Far : Recovery: Despite lawsuits and bad publicity arising from its role in the O.C. fiscal crisis, the brokerage is charging ahead to big-time profits.
This could have been the worst of times for Merrill Lynch & Co.
Its longtime client Orange County lost $1.7 billion in bad investments and pinned the blame on Merrill in a highly publicized lawsuit. Top executives were subpoenaed to appear before California lawmakers, who excoriated them, even as federal regulators scrutinized the Wall Street giant’s financial dealings with the county treasurer.
With skillful damage control, however, Merrill has managed so far to shrug off the nation’s largest municipal bankruptcy and has rolled on to post some of the highest profits in its lengthy history.
To be sure, the firm worked hard to protect its reputation.
It hired a major California lobbying firm, flew out New York executives to hand-hold local customers, tapped veteran spin-control experts and compiled a 100-page booklet for clients called “Setting the Record Straight.”
Merrill’s bottom line has remained Teflon-coated:
* The company is expected to earn about $1 billion in 1995, more than any other brokerage firm and its third straight year of 10-figure net income. This year should be the second most profitable in Merrill’s history.
* Merrill hasn’t been blackballed in the halls of California local government. It is still the largest underwriter of municipal bonds in the state, with $3 billion sold this year. Aggressive, low-ball pricing has been key.
* Except for those directly connected with Orange County, Merrill seemingly hasn’t lost a major municipal client in California since the bankruptcy. Some cities here, including one as important and lucrative as Anaheim, continue to use Merrill to sell securities. Local companies continue to pick Merrill to sell their stock on Wall Street.
* Merrill’s stock price has more than recovered from its initial drop, nearly doubling since to $55.13 a share.
Stock market conditions helped, of course, as Merrill caught the same profit wave boosting most investment banking and securities firms this year. But Merrill is riding a little higher than the rest.
“The environment in 1995 has been very kind to Merrill Lynch,” said Haig Nargesian, a senior analyst at Moody’s Investors Service Inc. in New York. “The main concern was whether customers would shy away from them because of Orange County. That hasn’t happened.”
Even so, Merrill faces some serious threats. After paying its half of a $24-million settlement in a highly-publicized Massachusetts municipal bond scandal, New York turned around last week and suspended the firm from a key leadership position in raising money for the city. Orange County is seeking $2 billion in a lawsuit against Merrill, and a judge on Friday allowed the lawsuit to proceed, a major setback for Merrill.
Calvert D. Crary, a longtime litigation analyst, predicts Merrill will be held “responsible to some extent for the losses” and will probably pay a settlement in the range of $500 million to $1 billion. Even that, according to one of his reports, could be done “without severe disruption of business” to Merrill.
As dismaying as Merrill’s prosperity may be to some, it provides some comfort to others.
“I’m pleased,” said William J. Popejoy, the county’s former chief executive, “because as a resident of Orange County, I’d hate to think we were suing someone who didn’t have the ability to pay.”
With roots more than 100 years deep, Merrill is a global powerhouse, a one-stop shop of high finance. Earning one-fifth of its revenue overseas, Merrill has 44,000 employees in 31 countries.
Armed with its extensive network of retail brokers that serves both individuals and companies, Merrill is the largest custodian of individual assets in the world, holding $675 billion for its individual clients, an increase of 18% from last year.
Merrill has remained the leading underwriter of corporate debt worldwide with a 18.2% market share during the first 11 months of this year, according to Securities Data Co., a research firm in New Jersey.
And in the year since Orange County’s Dec. 6 bankruptcy filing, Merrill remains the 600-pound gorilla in the business of selling and trading bonds that finance America’s local governments.
One of its biggest clients was Orange County, where the firm underwrote major bond deals, lent the county money to leverage its investment pool and sold it many of the riskiest investments in its portfolio. The business was lucrative; in just 1993 and 1994, Merrill said, it earned $62.4 million in fees.
The once-sleepy and secretive municipal bond arena has posed the greatest troubles for Merrill this year, even beyond the borders of Orange County.
Merrill and Lazard Freres & Co. agreed in October to pay more than $24 million to settle civil charges that they defrauded four public agencies in Massachusetts. It was the largest settlement in the history of the bond market.
Because of the Massachusetts settlement, New York City said last week it would limit Merrill’s role in its municipal underwriting, suspending the firm from its top-notch position until next summer.
Although Merrill earns only 5% of its revenue from municipal bonds and competitors, like Lazard, are dropping out because of the scandals, Merrill plans to stay in the market because legions of the wealthiest clients covet the tax advantages.
“As the largest custodian of consumer assets in the world, this is an important service,” said Jerome P. Kenney, executive vice president of corporate strategy and research for Merrill. “There is no chance that Merrill would leave the municipal business.”
As a result, Merrill has fought hard to safeguard its California municipal turf. Not only have they spent hours addressing clients’ concerns, they’ve retained market share by underbidding competitors.
“They are becoming a kind of the Wal-Mart of munis,” said one banker, who has competed with Merrill for business. “They always come in with the lowest bid.”
Merrill’s market share has slipped slightly from last year in deals where the underwriter has a more long-term role--and it has likely lost some clients--but the dip has been hardly noticeable.
“We spent a lot of time with issuers in California,” said Kenney. “We were relatively unaffected. They accepted this as more of an isolated event than an indication of a systemic problem or anything about our service.”
Although Merrill has been excluded from Orange County’s recovery-oriented bond sales this year, the firm continues doing business here in other arenas.
On the corporate side, it helped sell shares for the Irvine Co.’s publicly-traded apartment company. It also did a brisk business with individuals.
Herb Bennett, 38, a Merrill broker in Newport Beach, said he only lost two of his 200 local clients right after the bankruptcy, but one has already come back.
“Sure, a few of my clients were concerned that Merrill was going to be sued, lose all its clients and go out of business,” said Bennett. “But I explained it to them.”
Even more surprisingly, at least one Orange County city--Anaheim, which entrusted $169 million to the Orange County investment pool overseen by former Treasurer-Tax Collector’s Robert L. Citron and is still short $17 million because of its collapse--continues using Merrill to trade securities for its own $350-million investment pool.
“At this point, we are just looking for the best pricing--that’s my responsibility,” said City Treasurer Charlene Jung, who has picked Merrill brokers at least five times this year because they offered the lowest bids.
Jon Schotz, financial adviser for cities, schools and others that placed money in the county’s investment fund, said it is “unbelievable” that any Orange County city would continue using Merrill even as they sue the firm.
Orange County’s new treasurer-tax collector, John M.W. Moorlach, avoids Merrill completely.
“I would flip if Merrill showed up on our radar screen,” said Moorlach, who oversees the county’s nearly $2.6-billion portfolio.
The state of California seems to suffer no such qualms, having selected Merrill as one of its preferred bond dealers. Out of 120 applicants, all of which were asked to detail their involvement in Orange County, 67 firms were picked, including Merrill Lynch.
“It would have been presumptuous to overreact before all the facts were known,” because Merrill has not been charged with any wrongdoing in Orange County, said one state official who declined to be identified.
A concerned Los Angeles Metropolitan Transit Authority threw Merrill off its top-tier team of bond firms in the weeks following the bankruptcy, but restored Merrill’s status a month later.
“It was an immediate reaction to the bankruptcy,” said Les Porter, treasurer for the transit district. “They were concerned about the public policy implications. But we concluded that we were not in a position to judge those allegations.”
Etched in marble in the company’s gleaming World Financial Center headquarters in New York are five principles ostensibly embraced by Merrill Lynch: Client Focus, Respect for the Individual, Teamwork, Responsible Citizenship and Integrity.
Drafted in 1940 by company founder Charles Merrill, the principals are displayed on executives’ desks, outside elevators, in hallways and in company advertisements.
“We take them very seriously. This is how we operate--it’s not just something on the wall,” said Kenney, stressing the link between Merrill’s image and its profitability.
“Anything that impacts on our image--there’s nothing more important to this firm,” he said. “We are handling this Orange County situation in a very forthright manner.” Part of that is damage control.
Immediately after the bankruptcy, Merrill hired major lobbying firm Nielsen Merksamer in San Francisco, which helped campaign against bills this year that might have cost Merrill bond business.
Through the first half of the year, Merrill paid Nielsen nearly $205,000 in fees.
Merrill also prepared an extensive booklet called “Setting The Record Straight: Facts on the Orange County Bankruptcy,” which was distributed to employees and clients.
When word got out that UCI Prof. Philippe Jorion was writing a book on the Orange County bankruptcy titled “Big Bets Gone Bad,” he got an unsolicited call from Merrill spokesman Tim Gilles offering help.
“They were very worried when they heard I was writing a book,” said Jorion. “But they have been very good at damage control. In a way I wish the county was better. Their public relations has been very bad.”
Bruce Bennett, the county’s lawyer, notes that Merrill has had a representative at every county Board of Supervisors meeting since the bankruptcy and a lawyer present every time he speaks.
“Merrill has devoted substantial resources in terms of both people and dollars to protect its image,” said Bennett. “The county hasn’t been interested in that. We are fighting them in court.”
Just how much Merrill is spending to protect its image and to fight the county’s lawsuit isn’t clear. For the latest quarter, Merrill said its legal and professional fees rose 28% from last year to $114 million, but the company won’t divulge how much of its added fees are due to Orange County.
“The scandals have hurt them somewhat but it’s difficult to quantify how much,” said Perrin Long, analyst with Brown Brothers Harriman & Co. in New York.
So far, most of the Merrill bankers involved in the Orange County fiasco are still doing business in California.
Merrill salesman Michael Stamenson, who spoke daily with Citron, is still an employee “in good standing,” said a spokesman. Stamenson, involved in financial debacles in both Orange County and an earlier one in San Jose, is assisting investors from his San Francisco office.
Merrill continues to do bond business with its old partners on Orange County deals. The firm recently teamed up with Jeffrey Leifer, another longtime adviser to Orange County who is now under investigation for his activities.
Before the bankruptcy, Merrill and Leifer worked together last July on issuing a controversial $600-million note for Orange County, which was sold prior to the bankruptcy so that Citron could further his bets on interest rates.
The note has since defaulted, and is at the heart of allegations that the county and its financial consultants failed to make legally required disclosures to prospective investors.
This year, Merrill and Leifer cooperated on a $64-million deal for Sonoma County, where Merrill has been on the list of favored firms for the past 15 years.
“Even though we knew about everything going on and read about it in the papers, we’ve never had a problem with them,” said Sonoma County Treasurer Don Merz.
Because of its size and presence in California, Merrill “cannot be ignored,” he said, calling it unfair to blame Merrill for the bankruptcy.
“Everyone is re-examining themselves in the wake of this year,” Merz said. “You can’t point and say it’s brokerages or it’s treasurers or it’s the rating agencies. It’s a combination of all of us.”
(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)
Merrill Still Means Money
Except for a temporary drop in its stock price, Merrill Lynch & Co. has so far weathered its connection with the Orange County bankruptcy relatively unscathed. Its stock price, earnings, bond market share and California municipal bond business have continued to prosper.
Soaring Stock
Six days after Orange County declared insolvency, Merrill’s stock hit a 52-week low of $33.25. But in less than a year, the price nearly doubled--to an all-time high. 1995 monthly closing prices:
Oct. 13 (all-time high) : $64.13
Nov.: $55.50
Friday’s close: $55.13
****
Through the Bankruptcy. December, 1994, closing prices
County declares bankruptcy 12/6: $36.25
Dec. 15: $35.15
****
Profit Recovery
Merrill Lynch posted profitable years in 1993 and 1994, the latter a slow year for the securities industry. This year analysts are predicting Merrill’s earnings to top the $1 billion mark, making it the second most profitable year ever.
QUARTERLY NET INCOME (In millions:)
1995, 3rd: $300.4
****
Big Bond Business
Merrill Lynch consistently captures the largest or second-largest market share of long-term municipal bond issue underwriting nationwide. Through Nov. 30, the firm claimed 11.7% of this year’s market.
U.S.MARKET SHARE
And principal amount, in billions:
*--*
Market Share Amount ’90 11.3% $14.2 ’91 9.5% $16.1 ’92 8.6% $19.8 ’93 12.0% $34.8 ’94 11.1% $18 ’95 11.7% $15.1
*--*
****
Bull In the Bear-Flag State
Merrill maintained its share of California public debt bond issues after the Orange County bankruptcy. It shows no signs of slowing down this year, having 18% of the market through Nov. 30.
CALIFORNIA MARKET SHARE
And principal amount, in billions:
*--*
Market Share Amount ’90 5.8% $1.4 ’91 10.2% $3.6 ’92 5.7% $2.5 ’93 11.8% $6.7 ’94 10.5% $4.4 ’95 18.0% $3.1
*--*
****
Sign of the Bull: Growth
It’s no wonder Merrill Lynch is bullish on America. Founded as America’s first national retail brokerage, its history is one of virtually unbroken growth. In addition to its dominance of the U.S. domestic underwriting market, Merrill is a major force in global capital markets, operating in 31 countries. An overview of its growth, dollar amounts in millions:
REVENUE
1995*: $20,000
NET INCOME
1995*: $1,100
ASSETS
1995*: $165,000
EMPLOYEES
1995*: 44,000
* 1995 figures are analyst’s estimate
Source: California Debt Advisory Commission, Merrill Lynch & Co., Securities Data Co., Brown Brothers Harriman & Co.
Researched by DEBORA VRANA and JANICE L. JONES / LOS ANGELES TIMES
(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)
Key 1995 Events at Merrill Lynch
* Jan. 13: Orange County files suit against Merrill Lynch seeking $2 billion in damages, alleging the firm sold the county risky and illegal securities. Merrill Lynch denies charges.
* Jan. 25: Merrill names David H. Komansky president, putting him in line to become Merrill’s next chairman--a surprise move because Komansky was head of bond operations, a division under fire from its dealings with Orange County.
* Feb. 16: Richard M. Fuscone, a managing director with Merrill Lynch, along with Los Angeles investment bankers J. Timothy Romer and Elke Cheveney, testify before state Senate special committee formed to look into Orange County’s investment loss.
* March 13: Kemper Money Market Fund, a Chicago mutual fund that bought Orange County bonds from Merrill, sues the firm.
* March 16: Huntington Beach officials file suit against Merrill.
* April 18: Company reports first-quarter profits fell 39% to $227.3 million from a record quarter the previous year. Despite the drop, analysts call results “outstanding” and Merrill stock rises.
* May 16: After spending $750,000 in legal fees, Huntington Beach decides to drop suit against Merrill and county.
* May 17: County CEO William J. Popejoy meets with Merrill Chairman and Chief Executive Daniel P. Tully to discuss possible $1.1-billion settlement.
* July 18: Merrill’s second-quarter profit jumps 12% to $282.8 million, boosted by flurry of stock market activity.
* July 21: Merrill acquires Smith New Court PLC, an English securities firm with 1,500 employees and 11 offices. Price: $842 million.
* Sept. 18: Alliance of 12 California cities and water districts files suit against Merrill in San Francisco, claiming firm misled them.
* Oct. 17: Merrill says third-quarter earnings jumped to $300 million, 30% increase from 1994’s third quarter.
* Oct. 26: Merrill and investment firm Lazard Freres agree to pay total of more than $24 million to settle civil charges they defrauded four civil agencies in Massachusetts.
* Dec. 1: A federal judge rules that Orange County is the proper party to sue Merrill and that it can pursue its claim in U.S. Bankruptcy Court.
Source: Times reports
Researched by DEBORA VRANA / Los Angeles Times
