Stuff up, incompetence, who knows, but there is huge confusion surrounding the Commonwealth Bank’s latest $2 billion fund raising.

The Sydney Morning Herald is now reporting that the bank has been forced to can the issue in an embarrassing back down, with investment bank UBS stepping in to fill the breach with a revised $1.65 billion offer.

According to the paper, Merrill Lynch walked away from the deal prompting the CBA to hold an emergency board meeting early this morning.

According to newspaper reports CBA raised the Merrill Lynch money at an average of around $27 a share, $11 less than the $38 a share shareholders ponied up in October to fund the acquisition of BankWest from its stricken UK parent, based on a statement released last night.

The CBA then surprised this morning by asking for trading in its shares to be halted pending an announcement from the ASX at 10.40am. It followed-up this announcement at 11.03am requesting an immediate trading halt.

The request for a trading halt and the CBA’s letter were both posted on the ASX after a report on the Sydney Morning Herald‘s website at 10.11am saying the deal had been canned because buyers had walked away after the bank had mentioned that bad debts would be higher. The story said underwriter Merrill Lynch had walked.

An update at 10.25am then said UBS had picked up the underwriting from Merrill Lynch and that a deal would be done at $26 a share.

The SMH said in the report that the reason last night’s willing buyers has walked away was because “institutional investors jacked up last night over an admission by the bank that its bad debts would be higher than the market had expected.”

“The latest word is that UBS has managed to pick up the baton, relaunching the offer at $26 a share, or a 10.8% discount to yesterday’s closing price. The bank, in order words, dusted a dollar a share. The issue has also shrunk in size, to $1.65 billion,” the paper said.

That compares with brokers saying the Tuesday raising was $1,643m in the institutional placement priced at $27.00; and $357m under the previously announced $750m placement at a price of $28.37 with Merrill Lynch last week.

In last night’s statement, the CBA said:

The Commonwealth Bank of Australia (the Group) has completed a $2.0 billion capital raising through a combination of: an institutional placement (the Placement) of ordinary shares at $27.00 per share – a 5 per cent discount to the 5 day VWAP; and the previously announced volume weighted average price placement (the VWAP Placement). Favourable market feedback on the Group’s recent capital initiatives has allowed the Group to accelerate its capital raising plans and launch the Placement today.

In morning comment to clients, Goldman Sachs JBWere said:

Bad debt driven guidance downgrade: CBA increased guidance for FY09 impairment charge to 60bp, versus previous guidance of 40-50bp and GSJBW revised forecast of 65bp of average gross loans. The “majority” of the bad debt charge is expected to be seen in 1H09. This relates to previously announced large single name exposures.

We have downgraded earnings Per Share by -5.9% FY09, -3.0% FY10. Whilst our FY09 bad debt charge was previously in line with CBA’s downgraded guidance, we have added additional cushioning given the increasing uncertainty around CBA’s bad debt position (i.e. 2nd bad debt driven downgrade in 5 weeks).

It’s uncertain if this new CBA guidance on bad debts is the one referred to in the SMH report that supposedly caused the original placement to fall over.