The move comes as analysts predict that Merrill, the nation’s largest brokerage, will write down its mortgage investments by an additional $8 billion or more in the fourth quarter. Such losses could force the firm to raise even more capital.
The deepening red ink from the turmoil in housing-related debt has left banks and policy makers struggling to contain the damage to the financial system and the broader economy.
As the losses mount, cash-rich investors from the Middle East and Asia are cutting a wide swath through Wall Street. Since late October they have spent more than $22 billion for stakes in Bear Stearns, Citigroup, Morgan Stanley and UBS.
At Merrill Lynch, talks to sell stock to Temasek Holdings, Singapore’s sovereign investment company, began this summer but gathered steam in recent weeks after John Thain became Merrill’s chairman and chief executive on Dec. 1.
Thain, who revitalized the embattled New York Stock Exchange, is moving quickly to shore up the once-proud firm, long known for its “Thundering Herd” of stockbrokers.
Merrill Lynch also agreed on Monday to sell most of its commercial finance business, Merrill Lynch Capital, to the General Electric Company in a deal that would raise about $1.3 billion for other parts of its business.
“One of my first priorities at Merrill Lynch was to strengthen the firm’s balance sheet, and today we have made great progress towards that by bolstering our capital position through these investments and the sale of Merrill Lynch Capital,” Thain said in a statement.
To raise $5 billion, Merrill Lynch will sell new stock to Temasek at a discount to the recent market price.
It will sell an additional $1.2 billion of discounted shares to Davis Selected Advisers, a big money management firm based in Tucson. Together, these two investors will gain a stake of less than 10 percent in Merrill. Neither will have a role in the management of the firm nor any presence on its board.
Merrill may have to strengthen its capital position further given the likelihood of widening losses on its mortgage investments. “If, after fourth-quarter earnings, we find that we need to enhance it further, we will,” said a person close to the situation.
While news of Monday’s deals initially lifted its stock, the shares quickly wiped out their gain to close down 2.95 percent, at $58.90, in a holiday-shortened session. By selling new stock, Merrill will dilute the stakes of existing shareholders.
Temasek, which is controlled by Singapore’s finance ministry and manages a portion of the city-state’s foreign exchange reserves, has been stepping up its investments inside and outside Asia. In September it was invited by Barclays of Britain, along with the China Development Bank, to become shareholders, in exchange for a cash infusion that Barclays needed to improve its offer for the Dutch bank ABN Amro.
Other sovereign wealth funds have also swooped down on weakened Western financial companies. Singapore’s lesser-known government fund, the Government of Singapore Investment Corporation, recently agreed to invest $9.7 billion in UBS. Citigroup is selling a $7.5 billion stake to the Abu Dhabi Investment Authority. And last week, Morgan Stanley agreed to sell a $5 billion stake to the China Investment Corporation.
Thain’s other new investor, Davis, held talks with several financial firms before settling on Merrill. The money management firm, which oversees $100 billion in assets and is known as a value investor, contacted Merrill two weeks ago, sensing the Wall Street firm was eager to raise money, according to people close to the situation.
“We think it is a very powerful franchise trading at a very attractive valuation, and frankly, time is their friend,” said Kenneth Charles Feinberg, co-portfolio manager for Davis. He said Davis intended to hold its stake for “many, many years.”
While they are based on opposite sides of the world, both Temasek and Davis have a record of buying beaten down stocks and holding them for long periods. Both also have significant investments in financial services firms. Temasek’s holdings are largely in Asia. Davis has big stakes in blue-chip companies like American Express, AIG and JPMorgan Chase.
Davis Select was founded in 1969 by Shelby M. C. Davis, whose late father, Shelby C. Davis, was a prominent investment banker and economic adviser to Thomas Dewey, the former New York governor and presidential candidate. Davis himself was a vice president of Bank of New York before he founded Davis Select.
Davis funds generally do not take controlling stakes, but they are known to have an activist bent, especially when it comes to corporate governance issues. Davis is also particular about how much firms pay their top management. When investing in a company, its fund managers regularly ask about what kind of performance is necessary to prompt bonuses for executives.
When Merrill hired Thain away from NYSE Euronext, it offered him a sign-on package that could be worth more than $120 million if Merrill stock rises more than $40 a share in the next two years.
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