Merrill Lynch Is Junk

John Thain, the new chief executive of Merrill Lynch, is this weekend in talks with Chinese and Middle Eastern sovereign wealth funds that could lead to the sale of another big stake in the US bank in a desperate bid to raise capital, according to sources in London and New York.

The discussions come just days after Thain was forced on Christmas Eve to sell $4.4bn (£2.2bn) of stock to Singapore investment firm Temasek as part of a wider plan to raise some $7.5bn.

Merrill Lynch has already taken an $8bn hit related to sub-prime investments, but Wall Street fears that the bank's problems could go far deeper. 'Thain is desperately seeking an additional infusion of foreign capital to bolster Merrill's balance sheet,' said one source. 'It could be done by selling shares or other assets to raise cash.'

A US observer said: 'The multi-billion cash injection from Temasek was not enough and Thain is taking calls from a host of other potential saviours, which are understood to include sovereign fund investors from the Gulf and China.'

Analysts believe that Thain needs funds urgently in a bid to thwart future liquidity problems. The bank has already announced plans to lay off 1,600 staff. 'Thain is raising capital in anticipation of a large fourth quarter write-down,' said Sanford Bernstein analyst Brad Hintz.

Sources close to Merrill Lynch say that Thain has cancelled New Year leave among his top lieutenants and that his team is working around the clock on various 'scenarios' that could be employed to save the bank if problems related to the credit crunch continue to worsen.

'It is all hands to the pumps here,' the source said, adding that the possibility of exploring a merger with another banking group had not been ruled out but was considered 'an extreme scenario'. 'Everything is on the table,' he said.

Fears are mounting that Merrill Lynch will be forced to write down between $10bn and $15bn worth of assets related to CDOs - so called collateralised debt obligations - when it reports financial results next month. Stan O'Neal, the bank's former chief executive, was forced to resign when Merrill revealed write-downs in November.

Under strict new accounting rules enforced in 2004 by the Securities and Exchange Commission, Wall Street banks are required to have certain levels of liquidity to match their obligations, just like ordinary high street banks. This has prompted the likes of Merrill Lynch, Citigroup and UBS to seek large cash injections from foreign investors amid the worsening credit crunch.

Aside from the $4.4bn share sale, Merrill Lynch agreed to sell its middle-market lending business, Merrill Lynch Capital, to GE Capital, freeing up $1.3bn in equity. The troubled banking group will also sell an additional $1.2bn worth of stock to Davis Selected Advisers.

Analysts have so far predicted that the bank will be forced to write down between $10bn and $11.5bn, but the value of the assets affected by the credit crunch is falling in value by the day as the market continues to seek a way out of one of the worst liquidity crises in history.