Last updated: July 29, 2008 12:31 am

Merrill in new cash call and write-offs

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Merrill Lynch on Monday underlined the depth of the credit crisis by taking dramatic action to bolster its depleted balance sheet, revealing an $8.5bn (£4.3bn) share offering and $5.7bn in writedowns linked to the sale of toxic mortgage securities.

The move comes only 10 days after the US investment bank reported a $4.6bn second-quarter loss, including a $9.4bn write-down, and announced asset sales aimed at raising $8bn in much needed capital. It has been forced to raise more than $26bn from outside investors, including the latest share offering.

Financial stocks rallied in the days following the earlier announcement as investors grew more confident they had seen the worst of the credit crisis. But the latest Merrill writedowns raise new questions about whether banks themselves understand the extent of their problems.

Monday’s moves also underscore the crisis facing John Thain, chief executive, as he tries to nurse Merrill back to health. The bulk of the writedowns – and much of the bank’s problems – arise from its role as the largest generator of mortgage-backed collateralised debt obligations.

The latest announcement came after the close of trading in New York. Merrill shares ended down 11.59 per cent at $24.33 amid speculation of another imminent gloomy announcement.

Merrill said that it would sell CDOs with a nominal value of $30.6bn to Lone Star Funds, a distressed-debt investor. At the end of the second quarter, the bank had estimated the value of the CDOs at $11.1bn. However, it said on Monday that it was selling the securities for just $6.7bn, or about 22 cents on the dollar.

The cut-price sale could put pressure on other banks to slash the value of similar holdings, deepening their financial woes.

Merrill also agreed to cancel CDO hedges with XL Capital Assurance, the bond insurance group, and said it had entered into settlement negotiations with other bond insurers. The bank will write down $500m related to the cancellation of hedges with XL and a further $800m related to potential settlements with other bond insurers. With the $4.4bn loss on the CDOs, Merrill expects a third-quarter writedown of $5.7bn.

Temasek, Singapore’s sovereign wealth fund, has agreed to buy $3.4bn worth of the $8.5bn public offering in a deal that will enable Temasek to avoid paper losses on the $5bn it invested in Merrill at the end of last year.

Merrill has also entered into talks with the Kuwait Investment Authority to reset the terms of its original investment – similar to the deal it reached with Temasek, say people familiar with the situation. That reset is likely to enable the KIA to avoid losses on its current stake a loss that could incur the anger of Kuwait’s parliament.

Meanwhile, rating agencies have warned Merrill that it risks being downgraded to junk status if it sells any of its valuable stake in money manager BlackRock.

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