Merrill shocks Wall Street with $8.5bn share sale

Merrill Lynch, the investment banking giant that has lost more than $40bn (£20.1bn) on its mortgage investments since the start of the credit crisis, shocked Wall Street last night with plans to raise $8.5bn in new shares.

As part of a sweeping financial restructuring, the company is dumping most of its remaining holdings in risky mortgage derivatives and tapping the Singapore government for an emergency $3.4bn cash infusion.

Existing shareholders will have their stakes in the company viciously diluted by the new share sale, and anger last night immediately focused on John Thain, chief executive since last November, who had promised on more than one occasion in recent months that Merrill did not need to raise new equity capital.

Instead, he had told shareholders he would raise money through selling assets, such as Merrill's 20 per cent stake in the Bloomberg financial information business, which it offloaded this month for $4.4bn.

Mr Thain gambled yesterday that the dramatic new moves to rid Merrill of its toxic mortgage portfolio would be enough to restore confidence, and that they would be seen as a once-and-for-all clean up of the company.

A portfolio of mortgage derivatives known as collateralised debt obligations (CDOs) that Merrill had valued at $11.1bn as recently as a fortnight ago, were offloaded last night for $6.7bn. Before the credit crisis struck, that portfolio had been worth $30bn.

"The sale of the substantial majority of our CDO positions represents a significant milestone in our risk-reduction efforts," Mr Thain said. "Our consistent focus has been to opportunistically reduce risk, and, in order to take advantage of this sizeable sale on an accelerated basis, we have decided to further enhance our capital position by issuing common stock."

The $8.5bn share sale will be substantially dilutive to existing shareholders, since it equates to more than a quarter of Merrill's current market capitalisation. Temasek, the investment arm of the Singapore government is contributing $3.4bn to the fundraising, adding to the $4.4bn it invested in the company last December and underscoring again the new global financial power of sovereign wealth funds from emerging market countries. Temasek also contributed £160m to the recent fundraising by Barclays in the UK.

The news of Merrill's financial restructuring came after a day of mounting rumours it was facing new writedowns, just 11 days after it had posted its last results, containing a bigger-than-expected $9.4bn of writedowns. Its shares sunk 12 per cent to their lowest close in almost 10 years.

The firesale of the majority of the remaining portfolio will trigger another $4.4bn writedown for the next quarter's results, and the winding down of hedge positions will add a further $1.3bn.

Risky mortgage derivatives have become all but impossible to value while the US housing market remains in freefall, since their value ultimately derives from the value of the underlying collateral – namely, US houses.

Merrill executives hope the sale of the bulk of its holdings will create some clarity about the value of the company's remaining assets. Some of that optimism was reflected in the share price in after-hours trading last night when the stock, which originally slipped further in the wake of the announcement, staged a modest rebound.

Mr Thain – a former Goldman Sachs executive and most recently head of the New York Stock Exchange – arrived at Merrill last November after the sacking of Stan O'Neal, the former chief executive, who had pioneered the company's push into risky derivatives markets and turned Merrill into one of the biggest issuers of CDOs.