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By Tenzin Pema
BANGALORE, June 11 (Reuters) -J.P. Morgan Securities said it expects Merrill Lynch & Co Inc MER.N to post a loss in 2008, and substantially cut its second-quarter view for the Wall Street investment bank mainly due to ineffective hedging, slower client activity and likely writedowns from monoline exposures.
Shares of Merrill, which earlier fell to a new five-year low of $36.16, pared some of its losses and were down more than 4 percent to $36.27 in morning trade on the New York Stock Exchange. They have plunged 32 percent so far this year.
With the recent credit rating downgrades of the world's largest two insurers, MBIA Inc (MBI.N) and Ambac Financial Group ABK.N, Merrill may have to raise its credit reserves for its $7.8 billion gross exposure to monolines, analyst Kenneth Worthington said.
"While MER has reserved against its monoline exposure, it's unclear if it reserved enough," he added.
On June 5, Standard & Poor's stripped the bond insurance units of MBIA and Ambac of their top ratings, formally ending their "AAA"-guaranty business. The riskiest exposures banks hold to the monolines is through insurance they purchased on debt backed by risky assets such as residential mortgages.
On Monday, S&P said Merrill has one of the largest exposures to these types of assets, with $18.8 billion in super senior asset-backed collateral debt obligations as of March 28. Merrill wrote down $1.34 billion of this exposure in the fourth quarter of 2007 and the first quarter of 2008.
Worthington now expects Merrill to break even in the second quarter, compared with his prior view of a profit of 62 cents a share. For 2008, he expects Merrill to post a loss of 4 cents a share, compared with his prior view of a profit of 86 cents a share.
Among 17 analysts covering Merrill, Worthington ranks sixth in the accuracy of his earnings estimates, according to data compiled by Thomson Reuters.
Worthington is the latest in a growing line-up of Wall Street research analysts to forecast losses at Merrill from ineffective hedging.
"The performance of the cash positions and the index based hedges have diverged, resulting in less effective or value destroying hedges this quarter," Worthington said.
Leveraged loan exposure for Merrill continues to be a burden, he said. He, however, expects asset sales during the quarter to reduce exposure even with ineffective hedges.
The analyst maintained his "neutral" rating on the stock. (Editing by Jarshad Kakkrakandy)