Merrill Lynch's painful lesson in subprime

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Tim McLaughlin
On the same December day Merrill Lynch & Co. Inc. paid $1.3 billion for a subprime lender, the world's largest brokerage got a rude introduction to risky mortgages.
Merrill Lynch's newly minted First Franklin Financial Corp suffered a loss of nearly $300,000 on a soured home loan to a lab assistant from a gritty, blue-collar town north of Boston.
Problems with subprime mortgages have buckled Wall Street-run hedge funds, roiled global credit markets and pushed several of First Franklin's rivals into bankruptcy, leaving thousands of U.S. workers jobless.
And First Franklin's lawsuits against mortgage brokers show the San Jose, Califorina-based lender has experienced the same problems as the rest of the industry. Court papers show First Franklin has been burned by lax underwriting, fraudulent home appraisals and borrowers exaggerating their incomes.
A few bad loans at First Franklin are not a disaster for Merrill Lynch, a financial powerhouse with $1 trillion in assets, But the subprime mortgage industry's crisis has sidelined Merrill's strategy for buying the lender in the first place. Home loans generated by First Franklin are the raw material Merrill Lynch packages into mortgage-backed bonds sold to investors. That market has nearly evaporated.
Merrill Lynch executives are not sure if First Franklin will add to 2007 profits, as they had forecast last year.
So far it appears to be a drag on earnings.
"It wasn't the best move," said John Meara, president of Argent Capital, which owned 309,000 Merrill shares at the end of June. "It's not going to make or break the company, and I'm sure the company didn't factor in what's happened to the subprime industry. It's hard to predict Armageddon."
Merrill declined to provide any detailed information about First Franklin's performance. But recently filed reports with U.S. banking regulators show that Merrill Lynch Bank & Trust Co., where a lot of the First Franklin franchise is housed, lost $111 million through the first half of 2007. Securitization and trading revenue tied to First Franklin's loan making are not included in that unit's results. — Reuters