Level 3 Asset Watch

DJ Merrill Level 3 Assets $82.4B At 1Q End, 8% Of Total Assets
Tuesday, May 06, 2008 4:37:57 AM (GMT-07:00)

Merrill Lynch & Co. (MER) said Tuesday that its Level 3 assets at the end of the first quarter increased nearly 70%, to $82.4 billion, from $48.6 billion at the end of the fourth quarter.
The Wall Street firm said the Level 3 assets, which include assets measured at fair value on a recurring and non-recurring basis, increased because of the recording of trading assets, for which the exposure was previously recognized as derivative liabilities at the end of the fourth quarter.
The company said it also transfered $5.6 billion of European commercial real estate mortgage loans into level 3 that had previously been classified in Level 2.
"During the first quarter of 2008, there was a decrease in the liquidity for these products, resulting in the increased use of unobservable inputs to derive their fair value," Merrill said.
In its quarterly report filed with the Securities and Exchange Commission, Merrill said Level 3 assets as a percentage of total assets amounted to 8% at the end of the first quarter, compared with 5% at the end of the fourth quarter.

In an earlier post I talked about level 3 assets as the bucket that banks dump the stinkiest of their dirty laundry into. Management literally guesses what the asset is worth and assigns it that value. Here's an interesting screenshot that captures the current top 18 companies sorted by their level 3 assets:




Merrill is number 3 at the moment. Citigroup and Goldman Sachs own the number 1 and 2 spots respectively. The question that continues to nag me is if by definition level 3 assets are assigned a best guess value in the first place, how can we take seriously what a company says they have in their level 3 bucket? Where's the tipping point?

If it were not for financial institution convertible security secondary offerings floated to shore up their sick balance sheets, investment bankers would have little to no business to speak of so far this year. That would make their balance sheets look even worse.

I see more writedowns to come.