Merrill Lynch (MER) issued a press release after the close with the encouraging title “Merrill Lynch Announces Substantial Sale of U.S. ABS CDOs, Exposure Reduction of $11.1 Billion”. Beyond the title, Merrill will be selling $8.5B in new equity and taking an additional $5.7B in write downs in the third quarter. Temasek Holdings (Singapore), currently Merrill’s largest shareholder, will purchase at least $3.4B of the new offering. Temasek bought into Merrill’s first round at the equivalent of $48 per share. Merrill will pay Temasek $2.5B to buyout its reset provision. Temasek will apply this $2.5B to its $3.4B commitment. That’s only part one of three.

For part two, Merrill will sell $30.6B face value super senior ABS CDOs to an affiliate of Lone Star Funds for $6.7B. CDOs were previously marked down to $11.1B, so this further write down comprises $4.4B of Merrill’s $5.7B third quarter write downs. Merrill will finance 75% of the sale. Sounds like “The UBS Shell Game”. If Merrill is financing the deal, how are they out of the woods? The recourse is only to the assets sold.

Part three is XL Capital Assurance’s (XL) buyout of their CDO insurance for $500M. Merrill will record a loss of $500 based on a book value of $1B for the hedge. An additional $800M loss is expected in settlements with other monolines. Merrill is actively negotiating with MBIA (MBI). $4.4B + $0.5B + $0.8B = $5.7

More losses: The $2.5B payment to Temasek to buyout the reset will be considered a loss, and a $2.4B loss will be taken for additional dividends related to the mandatory conversion of preferred stock. Merrill claims the new common and preferred issues will eliminate all reset provisions from the first round.

To instill confidence, Merrill’s management will purchase 750K shares of the new issue. The press release has several tables showing Merrill’s improved capital position and reduced risk. Merrill claims a Tier 1 capital ratio of 10.5% and book value of $22.21 pro forma, after these transactions. CNBC reported Merrill will incur a 20% dilution.

Disclosure: Author is long MBIA.