Chapter 1 – Mini Case

An Interview with John Thain, the Chairman and CEO of

Merrill Lynch
In August 2008, Merrill Lynch, one of the world’s largest investment banks,
announced that it would have to raise a massive $8 billion in capital to offset its
losses in the previous year. The following is a transcript from an interview
between Maria Bartiromo, a CNBC presenter, and John Thain, the chairman and
chief executive of Merrill Lynch, on Bartiromo’s CNBC show, “The Closing Bell”.
The interview is reproduced from the website www.clusterstock.com.

The interview covers many issues relating to the reason why firms raise capital,
the issues they face, and the link between financial markets and corporate
strategy. There are a number of new terms you need to face, but that is one of
the challenges of studying the financial markets!

Maria Bartiromo: It has been exactly a week since Merrill Lynch announced
dramatic writedowns on its collateralized debt obligations and said it would raise
more than $8 billion of new capital. The move helped stabilize the market. It put
a floor under the company's shares for sure and it is really the talk of the town.
In his first appearance now since that news came out the man behind the
decision joins me in a CNBC exclusive. Merrill Lynch chairman and CEO John
Thain. John, nice to have you on the program.

John Thain: Maria, it's always great to be back at the exchange.

Bartiromo: Welcome back. That's right. Having run the exchange. You took
extraordinary steps in the last week and a half, selling more than $30 billion
worth of CDOs for the bargain price of 6.7 billion. 22 cents on the dollar. why
now? You had valued these securities at, what, 36 cents on the dollar at the last
quarterly report, and now you sold them at this point, 22 cents. Why take the hit
and do this sale immediately?

Thain: Well, Maria, if you look at our business in the second quarter, the work of
60,000 employees generated $7.5 billion of revenues and almost $2 billion of
free tax income, but all of the efforts of all those people were wiped out by the
declines in the asset values and the increase in reserves against the mono lines
that supposedly hedged these assets. These assets that we sold accounted for
about 70% of all the losses we've taken over the last 12 months. So when we
had the opportunity to sell them and to sell them in a bulk sale, which obviously
has a bulk discount price to it, and to raise the capital at the same time, we took
advantage of that opportunity because it's a great risk reduction trade, it puts us
in a much better position to manage our business going forward, and with the
new capital we're very well capitalized.

Bartiromo: You know, a lot of people are talking about the transaction. They
want to hear details of it. The fact that Merrill finances 75% of the transaction.
But let me get your comment on something one of the holders of your stock said
the other day. He said the sale doesn't close for 60 days and if you defer the
transaction you possibly could have avoided the anti-dilution payments. But you
did it now, immediately. Was someone pressuring you to do it, the ratings
agencies, treasury? Why now?
Thain: There really was no pressure. We chose to do this. This was a transaction
we chose to do. The reasons we did it now was, one, that we could. So we had
the buyer lined up. We had negotiated a trade and waiting, waiting until January,
certainly ran the risk to us that these assets continue to deteriorate in value and
that they cause further losses between now and January.

Bartiromo: A lot of people felt that when you first came in, when you first came
in the job you were going to do this, and then you said, well, we don't need to
raise capital at this time, I'm going to get back to that. But let me ask you that,
where are you now? So with all of the CDOs being sold, how would you
characterize the level of level 3 assets, or the securities, which are comparable
to the securities that don't have a market? Are you done?

Thain: Well, let me answer it this way. We have since the beginning of the year
been reducing assets and particularly those risky and less liquid assets. When we
began the year, you know, we reported an $8.6 billion loss for 2007. we raised
$12.8 billion to cover that loss. so we had a $4 billion-plus cushion. But since
January 1st and June 30 the value of these assets has declined dramatically. So
just to give you an idea, the single A ABX [an index reflecting the value of sub-
prime mortgages] is off 70% from January 1 to June 30. So what was true in
January isn't necessarily true in June, and we have been shrinking our balance
sheet. We have been selling assets and this is really just a continuation of that
process.

Bartiromo: So what is left at this point? I mean, who's to say that what you
have on the books today is not going to be worth a lot less in September? Is it
fair to say there will be more writedowns?

Thain: No, it's not necessarily fair to say that. We have dramatically reduced our
risk with this trade. As i said, 70% of our losses came from these assets
[subprime mortgage assets], but we still have risky assets on our balance sheet.
We have brought down our subprime exposure to a billion dollars. we've brought
all the A [risky bonds] exposure down to a billion and a half dollars. We've cut
our leveraged loan exposure in half to about $7.5 billion. We brought our
commercial mortgage exposure down to about 15 billion excluding what's in First
Republic [a private bank owned by Merrill]. So we are much smaller in terms of
risky assets, but it's not zero, and so if asset values continue to fall, particularly
mortgage assets, we still have some exposure.

Bartiromo: Will you need to raise additional capital?

Thain: Well, as you saw in our capital raise, we sold $9.8 billion of stock, and we
did that overnight. That is the largest non-IPO equity underwriting ever done, so
that $9.8 billion is much, much more than the write-off from these assets. The
pretax write-off on these assets is about 5.7 billion, so we have a big cushion and
that positions us well going forward, but unless you tell me where asset prices
are going to go over the next six to twelve months, I can't answer that question.

Bartiromo: So you're not going to say categorically -- you're not going to put
yourself in that corner again?

Thain: Well, no. I'm going to say the same thing I said before. Today we are well
capitalized. Today our tier 1 equity to risk weighted assets, which is the measure
most people look at, is about 11%. That's a very comfortable position for us. So if
the world stays the way it is, if asset values don't decline, we will definitely not
need to raise more capital. So today where we are we're well capitalized.

Bartiromo: You've got to be very measured and very careful in what you're
saying because investors are hanging on every word that you say and this is
beginning to impact your credibility. That's where I want to turn to right now. A
number of people said to me, look, I've heard him on conference calls, I had
investor meetings with him, and he said to me categorically we are not going to
need to raise capital, we are not going to have to go outside and get more
capital because of these losses on the mortgage securities. Listen to what one of
your shareholders said to us on CNBC earlier today.

Barry Ritholtz: My biggest concern is not just that he's saying things that seem
somewhat ambiguous or subject to reversal but this is now going on for eight or
nine months and it seems every month we get a different statement.

Bartiromo: What changed, and what are your plans to restoring the credibility
to answer critics like that?

Thain: Well, Maria, what i said at the time, at the end of the year, at the end of
the first quarter, at the end of the second quarter, was true at that time. So as i
said, at the end of the year we had more than enough capital. Asset values
continued to decline. We continued to shrink assets, but asset values fell. At the
end of the first quarter we lost $2 billion. We more than replaced that with $2.7
billion of new capital. We've always said that we would raise capital as we
needed to to replace any losses and if they entered the second quarter asset
values continued to fall. So we raised capital through the sale two of assets. We
chose to sell these CDOs at this time. The capital raised in the common stock
market was tied completely to that sale. So if we hadn't sold the cdos or if we
couldn't raise the capital the CDOs wouldn't have gotten sold. So we decided we
wanted to sell the CDOs, that's what triggered the need for new capital. If we
hadn't sold them we wouldn't have gone into the stock market.

Bartiromo: So is it fair to say that this market is so fluid still that it's very
difficult still today after all of the extraordinary measures that you've taken, and
they are extraordinary, having been able to sell that amount of CDOs in the
market, having been able to raise the money that you have, not just this most
recent recap but all year, is it fair to say that you still are in a position where you
don't know what the securities are going to be valued at and you don't know
what the market's going to look like in two months?

Thain: Well, unfortunately, no one knows what the market's going to look like in
the next two months, but today as we sit here we are well capitalized. Today we
don't need more capital. We have more than enough capital for our current
positions, but if you say to me the asset-backed market, the mortgage market is
going to go down another 70%, then that's not necessarily true. So statements
as to capital are good at the time you make them. You can't then go back and
say, well, John said in January he had enough capital. Well, in January we did.
That's not necessarily true in the future.

Bartiromo: John, we'll take a short break here. I want to get into the dividend.
All these questions about recapitalizations and raising money, and you've got a
5.5% dividend out there. I want to see if it's in jeopardy. We'll take a short break
and continue our conversation with John Thain when we come back.

Bartiromo: Welcome back to the "Closing Bell." We continue now with my

exclusive interview with Merrill Lynch chairman and CEO John Thain. John, before
we went to the break we were talking about your firm raising capital. Why pay a
dividend that's better than 5%? Now you have almost 60% more shares
outstanding given the dilution of what you did last week, and you're still paying
this 5.4% dividend. Any plans to cut the dividend?

Thain: Maria, we talk about the dividend every quarter. I'd prefer to get the
5.4% lower by getting the stock price higher, but when we think about the
dividend and the payout we think about it the following way. Our employees
own a lot of our stock, and the dividend's important to them as well as to all of
our shareholders and when we think about our profitability going forward, we
believe we will shortly be back to profitability and be able to earn the dividend.
So we don't want to take the short-term hit of cutting the dividend at this time.

Bartiromo: When you say you'll be back to profitability, when is that?

Thain: Well, we don't project, and we don't give guidance. but shortly.

Bartiromo: Shortly. Okay. 2008? No guidance.

Thain: No guidance.

Bartiromo: Let me ask you about something we just talked about a moment ago
with regard to raising capital. You're not going to cut the dividend right now. You
say you talk about it every quarter. What about the Blackrock stake [a financial
institution]? You have said on conference calls that this is a predictability to
earnings and you would rather not sell it right now. Can you categorically say
you're not going to sell the Blackrock stake?

Thain: We're not going to categorically say we're not going to sell anything
because that kind of a statement boxes you in, in a way you don't want to be.
We always have said we would think about any type of capital raise and try to do
what's in the best interests of our shareholders. So in the case of Blackrock
we've always said it's strategic. It's a very valuable asset on our books, but it's
important to our business going forward and right now what we did, actually we
talked with Blackrock, we extended and expanded our distribution agreement
with them.

Bartiromo: You say you don't want to box yourself in. John, you've already
done that. You've said many times you aren't going to raise more capital, and
then you did. Are you approaching further calls with investors and analysts
differently? Are you going to change what you're saying? And also, how could
things change so quickly? I mean, look, obviously, this is your business. You took
extraordinary steps last week, but the bottom line is if you say to me, Oh, yeah,
the CDO market changes dramatically, then maybe it is going to be a lot worse in
two months. Can that change that quickly in a two-month period?

Thain: Yes. Absolutely. And when we said we weren't going to raise more
capital, we said we were adequately capitalized at that point in time. If we lose
more money going forward, we may have to raise more capital and that was
always true. In the case of the CDO sale, if we had not sold those CDOs, we
wouldn't have gone into the stock market and raised capital. So the capital raise
was completely tied to the CDO sale, and we actually had to be able to do both.
So over last weekend we had to negotiate the CDO sale, and we had to get
comfortable that we could raise the common stock, and those two things either
happen together or not at all.

Bartiromo: Talk to us a little about the transaction, John, because this does
baffle many of your investors. I got a lot of talk from the people I've spoken with
about Merrill financing 75% of this transaction, and it was done on a non-
recourse basis except to the assets being sold. If those CDOs sold to Lone Star [a
private equity firm] fall in value on a market basis by more than 25%, can Lone
Star give it back to Merrill Lynch?

Thain: No. There's no put-back to us under any circumstance and the way the
transaction is structured, it is a true sale. We did finance 75% of it, but that's
quite normal in this type of a transaction and the way the cash flows are
designed, there is almost no -- not zero but almost no probability that we will
ever get these back. So we get a disproportionate amount of the cash flow to
pay our loan back, and the way that that is structured maximizes the chances
that we never see these again and it is in fact a true sale.

Bartiromo: So what are the conditions that Lone Star could put it back to
Merrill?

Thain: There's no put under any circumstance.

Bartiromo: Okay. That's what you need to get out because people are
wondering why it is you still have some down side risk because you're financing
75% of it.

Thain: Well, look, the simple thing is if they instantaneously went to zero then
we would have exposure to them. That's not happening.

Bartiromo: Okay. You're getting real applause for taking the big hit that you did,
taking the plunge on selling all of this, $30 billion worth of CDOs for the bargain
price. Do you think this is the new precedent? Are other firms going to follow in
your lead? Obviously, you're not going to be talking about the other firms, but
would you say now that this asset is 22 cents on the dollar?

Thain: Well the way to think about this is this is the first big trade on the CDO
market. There really has been no liquidity up till now. There's no question this
price was a bulk sale price. So we sold 11 billion on our books, we actually sold
30 billion, notional amount of securities, in one trade to one buyer. So that
doesn't mean where you can sell little pieces but it is the price where you could
get a big block off, and as I said to you before, this represents 70% of the -- of all
of the losses we've taken in the last 12 months come from these assets.

Bartiromo: How tough was that, John? How tough was it to get that trade done?

Thain: Very tough, because it was very hard not only to put the buyer together
and get both the pricing done and the financing done on the loan itself, but then
we had to get the permission with Temasek and our preferred holders and we
had to line up the stock offering all to make everything happen at one time.

Bartiromo: John, how is the job going? I mean, you know, it's been such an
extraordinary period. One of the analysts, Meredith Whitney from Oppenheimer,
said I want to know what is new today and what he didn't know when he first
took the job.

Thain: Well, it's not so much what I didn't know. I inherited a balance sheet that
was dramatically overloaded with illiquid mortgage-related assets, and over this
last seven or eight months the market has declined for these assets
dramatically. Bear Stearns [one of the world’s largest investment banks before it
went into difficulty in 2008] has gone out of existence. The problems with
Freddie and Fannie [government backed mortgage funds]. Credit spreads have
widened out dramatically. The world has gotten a lot more difficult, and we're
simply dealing with that and managing our balance sheet down and raising
capital as we need to.

Bartiromo: How will you resize the business to really face the realities of
everything that you just said? Let me get your reaction to something Joe Grano
[chairman of UBS Financial Services inc] told us about consolidation in your
industry. He was on "power lunch" on Friday.

Joe Grano: I think that trading desks are going to go down a third. I think
investment banks are going to go down a third in size. That's going to force
some consolidation. You could see a Merrill Lynch/Goldman combination, for
instance. It could happen.

Thain: Well, the good news about our mix of business, we have a very different
mix of business than a pure investment bank. So our wealth management
business, which is about half our revenues, doesn't use very much capital,
doesn't take very much risk, has great returns on equity, great margins, and has
been pretty immune to all the ups and downs in the marketplace. Over the last
12 months our wealth management business has raised $55 billion in net new
assets and about 70% of the revenues are annuitized, which means they're
recurring. So that piece of our business is very different than the traditional
investment banking, sales, and trading business. I think you and Joe and the
other commentators are correct that the traditional investment banking business
and particularly the sales and trading businesses will have less leverage, they
have to take leverage out, the returns will be lower, and that probably will force
some amount of consolidation, but in our case half of our business really isn't
susceptible to that.

Bartiromo: Interesting that you did take in new assets, even during this tough
period. You say wealth management is really not tied to what's going on, and yet
it's tied to the stock market, right? And we've had such a volatile performance.
How are you going to get -- you've talked in the past about accelerating the
growth outside the United States. Is that in the plans for wealth management?
Tell me about the global wealth management business and how you see that
business looking on the other side of this, when in fact we get through this
period.
Thain: Well, we have the best wealth management business certainly in the
United States and arguably in the world, and the growth of it is even stronger
outside the United States. So in the parts of the world where new wealth is being
created, in places like India and Brazil and China and Russia, those are places
that we can capture those assets, and it's also where our business mix is
particularly powerful, so that in a place like India, as those companies grow they
need capital. As they become more global, they want to make international
acquisitions, but the people who own the companies and control them are also
becoming very, very wealthy. So our ability to both market our investment
banking skills and trading skills and capture the wealth and manage it is even
stronger in those emerging growing parts of the world.

Bartiromo: John, I know you're really in the fishbowl of what's going on in Wall
Street and in the business. Here you are having done what you did last week and
experiencing the upset, but can you take yourself out of it for a minute and tell
me where you see things broadly speaking as far as the economy, as far as the
global markets today? Have we seen the bottom?

Thain: Unfortunately, I think the US economy is going to continue to be weak. So

if you look at the combination of falling home prices, rising unemployment, high
energy prices, both gasoline and however you heat your home, and rising food
prices, all of those are going to make it difficult for the consumer, all of which i
think makes the US economy slow at least into sometime next year [2009]. You
know, the rest of the world seems to be better, but I don't think the rest of the
world is decoupled from the US so I think those faster-growing parts of the world
like India, like China, like Brazil will do better, but I think it's going to be tough in
the US.

Bartiromo: Meanwhile, you're getting your own house in order even with new
hires. I'd like to talk to you for a minute about some of the new hires that you've
just put in place. A lot of people expect that we'll see another hire in equities
coming soon at Merrill. Tell me what else you're looking to do in terms of filling
your leadership team.

Thain: Well, what I've been doing over the last seven months is really filling out
the senior leadership team, and then they will fill out the team below them. It's
really a few hires. It's not a lot, but it will be a few senior hires and the team is
pretty much in place. Tom Montek started today, and Peter Krause will start after
Labour Day, and we already have a new CAO and a new CIO. We hired Ferris
Newgem from Bear Stearns, so I think we're in pretty good shape with maybe
one or two more hires.

Bartiromo: Do you think this slowdown and financial sector upset goes into '09?

Thain: Yes, absolutely. This is not going to be over in a couple of weeks.

Bartiromo: So how much worse do you think -- do you think it gets worse before
it gets better?

Thain: It's always hard to tell how much worse it gets versus when does it start
to bottom out, but I think the fact the US economy is going to stay weak means
it's not going to get better quickly.
Bartiromo: And what is your number one priority at this point, now that you've
gotten rid of this huge bulk of CDOs? How does it look different one year from
today?

Thain: The great thing about unloading this big pile of CDOs is that we really can
start to focus on our business going forward, and it really was overwhelming the
efforts of all the people so now I really do think we can focus on where can we
grow our business, what opportunities do we see in the world, both on the wealth
management side and the investment banking side. I think we can really start to
plan strategically where do we want to be not only one year from now but three
years and five years from now.

Bartiromo: John, you have not spoken a lot about this, and you actually have
come out pretty aggressively, taken the actions last week, and talked to us
today. Is there anything else you want to make sure shareholders take away
from this interview today?

Thain: Look, I think that on the capital raise we sold stock at 22.50. We're up $4
or $5. That's a very positive sign from the investor base that they understand the
strategy, they think we're going forward.

Bartiromo: Thank you for being on the program. John Thain, chairman and CEO
at Merrill Lynch.

____________________________

Questions

1. Why would John Thain find it necessary to come on to a television

programme to be interviewed about his decisions? What are the risks and
opportunities facing him?

2. Carry out your own research into what is meant by a CDO. CDOs were one
of the major news stories in 2007 and 2008, yet virtually no lay person
understood what they were. Write a small report, using diagrams to
illustrate your points, explaining what is meant by a CDO.

3. Why did Merrill Lynch sell CDOs for 22 cents on the dollar when the valued
them previously at 36 cents on the dollar? What reasons could you give
for such a drop in value over such a short period?

4. Explain why John Thain was slightly evasive when asked about raising
more capital. Looking back at the events at the beginning of August 2008
and considering the change in asset prices since then, do you think his
decision was right in raising capital at such a discounted rate?

5. When the CEO and Chairman of Merrill Lynch says the he does not know
where the market is going to be in 12 months time, what does this say
about the efficiency of the stock market and its effect on corporate
strategy?

6. Research into Blackrock and its relationship to Merrill Lynch. Why did John
Thain say that holding Blackrock shares was part of their corporate
strategy? From your own reading, explain his reasoning.