Merrill Lynch filed its annual report yesterday, revealing an addition $500m loss. Oops.
Restated, the company, bought by Bank of America last year, had a $27.6bn loss in 2008, instead of the $27.1bn previously reported.
The extra half billion of losses seems to have come from using the wrong yield curve on a swap contract and messing up the accounting on a single hedge in the fourth quarter. Here’s the relevant bit of the SEC filing:
Our parent company, ML & Co., may economically hedge fixed interest rate and currency exposure on certain debt by entering into swap contracts. In order to complete this strategy, ML & Co. enters into intercompany swaps with affiliates which then generally transact with external counterparties. During 2008, ML & Co. began using a different set of yield curves to value certain intercompany swaps than the affiliate that was the counterparty to the transactions. The yield curves used by ML & Co. did not incorporate certain factors needed to properly value the intercompany swaps and, further, the curves were not properly tested prior to implementation. The difference in valuations caused by the utilization of two different sets of yield curves was inappropriately recorded to a third party account which resulted in the intercompany transactions not being properly reflected in the consolidated financial statements.
Several mitigating internal controls were not operating effectively and therefore failed to identify the intercompany difference that resulted from the use of two different yield curves by the intercompany counterparties. These mitigating controls included the proper recording and reconciliation of intercompany derivative transactions and proper review and resolution of resulting reconciling items in balance sheet account reconciliations for two general ledger accounts.
In addition to the above material weakness, the contemporaneous documentation and fair value hedge effectiveness requirements of SFAS No. 133 were not applied appropriately for a single material hedge relationship entered into in the fourth quarter of 2008. As a result, hedge accounting was inappropriately applied to the designated hedge of certain long-term borrowings.
These items have been corrected and are appropriately reflected in the Consolidated Financial Statements in this Form 10-K.
Merrill’s auditors, Deloitte & Touche, had this to say:
In our opinion, because of the effect of the material weaknesses identified above on the achievement of the objectives of the control criteria, Merrill Lynch has not maintained effective internal control over financial reporting as of December 26, 2008, based on the criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
Another $500m of losses may seem like small change nowadays, but if Merrill can’t control its own books, then surely, Bank of America never had a chance when it came to doing due diligence on the deal — even though, as BoA’s Ken Lewis famously proclaimed, they’re really quite “good at this“.
Well, even if BoA were, it seems Merrill was not.
Related links:
Merrill understates losses by $500m – FT
“We’re good at this” – FT Alphaville