The third-largest U.S. securities firm lost $1.96 billion, or $2.19 a share, compared to a $2.16 billion gain, or $2.26 a share, a year earlier.

Over the first quarter, the company recorded more than $9.5 billion in write-downs and losses on subprime mortgages and other risky assets. It also posted $2.9 billion in net revenues (a 69% drop) and $805 million in investment-banking fees (a 40% drop) in “this challenging market environment, which continued to deteriorate during the quarter,” according to the company’s earnings release.

Merrill’s earnings missed analysts’ already low expectations, and it may cost the already struggling financial firm.

Citing “deteriorating conditions in the mortgage market” and the potential for another $6 billion in write-downs, Moody’s Investors Service said it may cut Merrill’s credit rating, which would be the second time in six months. In October, Merrill’s rating was lowered one level to A1, the fifth highest of 10 investment ratings, Bloomberg reported.

And some top investors are demanding better performance.

“Merrill Lynch has to show profitability,” Ken Crawford, senior portfolio manager at Argent Capital Management in St. Louis, which owns about 160,000 Merrill shares, told Bloomberg. “They can’t have negative return-on-equity quarters and expect to make investors happy.”

The rest of this year will be a true test for Chairman and Chief Executive John Thain, who took over Stan O’Neal’s post Dec. 1 after leaving his CEO post at NYSE Euronext (NYX).

“Despite this quarter’s loss, Merrill Lynch’s underlying businesses produced solid results in a difficult market environment,” Thain said in the company statement. “… we remain well capitalized. In addition, our global franchise is positioned strongly for the future, and we continue to invest in key growth areas and regions.”

Though Merrill and many financial service companies are still struggling to rebound from the subprime-induced credit crisis, there’s a small group of peer companies that may have put the worst behind them.

Goldman Sachs Group, Inc. (GSC) Morgan Stanley (MS) and Lehman Bros. Holdings Inc. (LEH) all beat earnings estimates last month.

Citigroup Inc. (C) – one of the hardest-hit financials – reports its first-quarter earnings tomorrow (Friday).