UPDATE 2-Merrill's bad debt sale to S.Korea agency stalls

(Adds datelines SEOUL/NEW YORK; source on transaction size, paragraph 2; shares activity, paragraph 5)

SEOUL/NEW YORK, Sept 4 (Reuters) - Merrill Lynch & Co's MER.N talks to sell bad loans to Korea Asset Management Corp (KAMCO) faced a deadlock due to a disagreement over price, the South Korean state agency said on Thursday.

An official familiar with the transaction said the talks centered on about $200 million in distressed assets from the bank's so-called 'scratch and dent' book, meaning mortgages that had defaulted or could not be easily repackaged.

Bloomberg reported earlier, citing KAMCO chief executive Lee Chol-Hwi, that the sale was faltering over differences in assessing the value of assets.

"We have been in talks with Merrill but couldn't narrow the price gap," said a KAMCO spokesman. "Now we'll drop the discussion so far and start a new round of negotiations."

Merrill Lynch's shares fell 7 percent in trading on Thursday to $26.35, amid a broad slump in financial stocks.

KAMCO declined to give details about Merrill's assets it seeks to buy.

The government debt clearer is also "keeping channels" with other U.S. institutions to buy distressed assets, the spokesman said, without elaborating.

Another South Korean state-controlled institution, Korea Development Bank, is in talks with Lehman over a possible joint investment with other Korean banks in the U.S. investment bank. [ID:nSEO69191]

In July, Merrill agreed to sell $30.6 billion of collateralized debt obligations, a kind of repackaged debt, to an affiliate of private equity fund Lone Star Funds, for just $6.7 billion, or about 22 cents on the dollar. (Reporting by Rhee So-eui in Seoul, Saumyadeb Chakrabarty in Bangalore and Elinor Comlay in New York; Editing by David Holmes and Louise Heavens, Gary Hill)