Merrill Lynch

By: Arend Adriaanse, Ratko Cvjetkovic, Richard Drais,

Melyssa Martinez, Alekhya Nandula, Emily Pruitt, Edwin
Smith, Cody Thompson, Felix Tsai, Garrett Willis
 History and culture
Why their strategy and risk attitude
changed
Breakdown synthetic CDOs
What led to their downfall
Why they were acquired by Bank of
America
Key Players
Ahmass Fakahany

Vice Chairman and Chief Administrative Officer

Osman Semerci
Head of Fixed Income
Arshad Zakaria
Head of Global Markets and Investment Banking
Tom Patrick
Chief Financial Officer
Stanley ONeals Number 2
Stanley ONeal
Born in Eastern Alabama
Joined Merrill Lynch in 1986 as a junk-
bond trader
Become CEO in 2002 and replaced
David Komansky
Was considered an isolated man and
appointed less confrontive counterparts
The main reason Merrill Lynch pushed
for the more risky trades, straying away
from more traditional practices
Shift in Business Strategy
Move from financial advisory business to Wall Street Investment
Bank

Stanley ONeal becomes President and CEO

Envy of Goldman Sachs and Lehman Brothers

Change in Mother Merrill culture

Greater emphasis on profits in the fixed income markets

Shift in Business Strategy
Push towards housing

Modeling after Lehman Brothers

Purchasing commercial and residential mortgage related companies

Acquisition of First Franklin

CDOs were full of mortgages and not higher grade corporate bonds
Disregard Of Risk
Disregard of Risk
Why was there risk?
CDOs were constructed with subprime mortgages and other bad assets that
did not offer high assurance of repayment
Synthetic CDOs
Merrill Lynch formed an internal unit and transferred the investments to it (this
created fabricated demand)
Why would internal unit accept toxic investments?
Million for a Billion
Disregard of Risk
Weve got the right people in
place as well as good risk
management and controls.
E. Stanley ONeal, 2005
Disregard of Risk
Ahmass Fakahany was the Vice Chairman and Chief
Administrative Officer
Fakahany began cutting the risk management staff in
2006
Wanted to put people in place that would say yes to
taking on the risky investments
Former Executives said that he loosened internal
controls
Disregard of Risk
Osman Semerci oversaw Merrills mortgage
operations and ran the Bond unit
Semerci often silenced critics who warned
about the risks the firm was taking
Several instances of employees being fired for
refusing to buy risky investments
Synthetic CDOs
Overview
Composed of complex culminations of options and derivatives
Primarily Credit Default Swaps (CDS)

Serves as an insurance policy to referenced entity

Referenced entity pays premiums for protection

Protection in the occurrence of a credit event

Similar structure to traditional Collateralized Debt Obligations

Cash flow

Centered around an underlying pool of securities

Tiered payout distribution

Classes
Composed of two different classes
Funded

Unfunded

Funded class puts up an initial investment in exchange for a share of

the synthetic CDO
Functions as a bond

Higher coupon rate

Higher up front risk / lower back end risk

Unfunded class receives payments throughout the life of the Synthetic

CDO in exchange for an assumption of liability
Key Differences (vs. CDO)
Funding
Cash-Based CDOs are fully funded - investors pay up front for their portion and the
capital generated pays for the underlying securities

Synthetic CDOs are only partially funded

Dont have liquid capital to cover CDO default in the event of an extreme credit
event

Liability is shifted to unfunded class when funds are depleted

Management
CDOs are actively managed

Synthetic CDOs are generally static

Protection Payout Structure
In the occurrence of a credit event, there is an ordered hierarchy in
how the funds are sent from the Synthetic CDO to the referenced
entity

1.Interest income from investment portfolio

2.Liquidation of investment portfolio

a. As needed

3.Remaining available capital

a. Primarily cash reserves from preliminary funded class investment

4.Unfunded class called upon to provide necessary remaining funds

Contribution to Financial Crisis
Between 2005-2007, $108B in generated Synthetic CDOs recorded
Experts suggest this number could be higher due to lack of regulation

Owners of Funded class lost original investment (and expected

returns)

Owners of Unfunded class liable for value of defaulted referenced

entity
Hedge Funds

Banks

Independent Investors
ML Implosions
Financial Analysis 2006 - 2008
2006: Merrill Lynch was doing very well
Spent $1.3 billion for First Franklin, specializing in risky mortgages

Had its highest revenue in history

Stock prices up 40%

2007: Has suffered lots of losses

Wrote down $8.4 billion of Mortgage Backed Securities

Removed Stanley ONeal and replaced with John Thain as CEO

Sold commercial finance to GE and sold shares to Temasek

2008: Lawsuit and agreement to be bought by Bank of America

Losses in Context
Sold once-valuable assets at
low prices:
CDOs that were once $30.6 billion
sold for $1.7 billion

Stock Price plummeted:

Stock which was once trading for $24
was $7 in February 2009

Bank of America purchased for:

$50 billion or $29 per share

70% premium -> overpaid by 70%

FOUNDERS AND CEOs
Merrill Lynch

Charles Merrill (1914-1958)

Edmundo Lynch (1914-1938)

David Komansky (1996-2002)

Stanley ONeal (2002-2007)

John Thain (2007-2009)

Bank Of America

Ken Lewis (2001-2009)

Brian Moynihan(2009-Present)
Bank of America Acquisitions
 Bank Of America Acquisitions
Publically announce
merge of Bank of
America and Merrill
Lynch
Lewis contacts Paulson Bank of America and
and Bernanke Merrill Lynch Merge
Bank of America Paulson and Bernanke Bank of America releases
shareholders approve threaten Lewis 2008 earnings report
merger

Nov 30 Dec 14 Dec 22 Dec 30

Sept 15 Dec 17 Dec 20 Jan 1 Jan 16

Dec 5

Merrill Lynch Merrill Lynch Merrill Lynch loses

loses $9 billion loses $12 billion Lewis speaks $15.3 billion
with the Bank of
America Board
Members
Conclusion
Questions??
References
1.http://www.nera.com/content/dam/nera/publications/archive2/PUB_C
DOs_Structure_Risk_Valuation_0713.pdf
2.https://www.hks.harvard.edu/m-rcbg/students/dunlop/2009-CDOmel
tdown.pdf

3.http://danwang.co/collateralized-debt-obligations-and-credit-default
-swaps/

4.http://www.nytimes.com/2008/11/09/business/09magic.html

5.http://www.vanityfair.com/news/2010/11/financial-crisis-excerpt-20
1011