In the weeks after Wall Street returned from the Labor Day holiday, the credit market picture appeared to brighten, with loans moving through the system and banks reporting numbers not nearly as bad as some feared.
But that picture turned gloomy again this week when Merrill Lynch and Co Inc posted a quarterly loss and a whopping $8.4 billion write-down, mostly from bad investments related to risky subprime mortgages.
The larger than expected write-down sent a fresh wave of anxiety across Wall Street and fueled fears that the woes of the credit market -- which impacts the buying and selling of everything from residential homes, to commercial buildings, to entire corporations -- were far from over.
The fear throughout the financial world is that there are more ugly numbers coming, making the current bloodshed in America's banking sector look like a scratch.
People are really afraid of the unknown, in the sense that nobody really knows what's coming, said Steven Rattner, managing principal of media-focused private equity firm Quadrangle Group. Nobody knows what all this exposure really amounts to. It's very opaque.
Bank exposure to the subprime mortgage mess is a major concern, as is exposure to hundreds of billions of dollars in leveraged loans from private equity takeovers stuck on their balance sheets.
Particularly worrisome for analysts and investors is the growing sense the banks themselves are unclear as to the exact value and exposure to mortgage-related investment pools known as collateralized debt obligations (CDOs). Merrill CEO Stan O'Neal said during the earnings conference call he misjudged the bank's exposure to subprime and he struggled to explain why.
I'm sure it's a hot topic of discussion (among Merrill's board). You know 'let's fire this guy (O'Neal) because he basically caused us to lose all this money because he didn't understand the business he was going into', said Punk Ziegel & Co analyst Dick Bove.
More write-downs could come if the world's largest brokerage further cuts the value of its remaining $20.9 billion exposure to collateralized loan obligations and subprime mortgages.
WORST MAY YET COME
In the meantime, the credit markets are holding up.
Energy Future Holdings Corp, the former TXU Corp bought by private equity firms, and its subsidiary, Texas Competitive Electric Holdings Co LLC, sold $7.5 billion in a three-part note sale on Wednesday, a source told Reuters Loan Pricing Corp.
But the feeling across Wall Street is that Merrill is not alone. With the credit markets trying to digest more than $300 billion in unwanted debt from leveraged buyouts, further troubles for the banks could spark a panic that pushes debt investors back out of the market.
We are not sold that we've seen the worst of the financials. We think there is significant exposure, said Scott Sperling, co-president of private equity firm Thomas H. Lee Partners.
The news from Merrill did not bode well for those who think they see the bottom of the market, Sperling said during an interview on Friday on business news channel CNBC.
Merrill also had a $463 million write-down, after fees, on commitments that include loans for corporate takeovers.
Merrill was the only big Wall Street firm to post a third- quarter loss. And its write-downs, before hedges, were bigger than the combined $3.6 billion in write-downs and charges recorded by rivals Goldman Sachs Group Inc, Bear Stearns Cos Inc, Morgan Stanley and Lehman Brothers Holdings Inc.
Many of us on the private equity side now see substantially more risk than we see upside, Sperling added.
(Additional reporting by Tim McLaughlin and Mark McSherry)