Lehman Faces Mounting Pressures
http://online.wsj.com/article/SB122103833291118977.html?mod=googlenews_wsj
By SUSANNE CRAIG, RANDALL SMITH, SERENA NG and MATTHEW KARNITSCHNIG
September 10, 2008 5:56 a.m.
Lehman Brothers Holdings Inc. came under mounting pressure Tuesday after hopes
faded for an investment deal with a Korean bank, helping to trigger a 45% fall
in the firm's shares.
Lehman's troubles mark the latest installment in the worst financial-system
crunch in decades, coming just two days after the U.S. government announced its
plan to take over the two giants of the mortgage business. U.S. stocks fell
Tuesday, giving back gains that had greeted the weekend bailout of Fannie Mae
and Freddie Mac.
The drop in Lehman shares highlights the continuing nervousness in markets as
the company attempts to raise fresh capital to offset sharp declines in the
value of its assets. Shares of Lehman, which is heavily exposed to troubled
real-estate investments, have been under pressure for months and were down
about 80% this year before Tuesday's drop. Investors have been frustrated as
Lehman has taken months to pull together a plan to raise capital to absorb
expected losses.
On Tuesday, credit-rating services Standard & Poor's and Fitch Ratings placed
their ratings on Lehman on review for downgrades. S&P cited uncertainty about
the firm's ability to raise capital, "based on the precipitous decline in its
share price in previous days." If downgraded, Lehman may be required to post
billions of dollars in collateral to its trading partners on derivative
contracts and other agreements.In an attempt to assuage investors, Lehman said
late Tuesday that before markets open Wednesday, it will offer a preview of its
third-quarter earnings and announce "key strategic initiatives."
The people familiar with the firm said Lehman plans to announce it is in talks
with money manager BlackRock Inc. to sell a package of primarily British
residential real-estate assets. Also, Lehman is expected to announce a separate
plan to spin off some commercial real-estate assets into a new company,
referred to internally at Lehman as SpinCo. The remaining portion of the firm,
shorn of much of its distressed real-estate assets, is being called CleanCo,
these people say.
Lehman has been shopping for investors to buy a piece of its
investment-management unit, which includes the profitable asset-manager
Neuberger Berman. Three private-equity firms are in the running for this
division, with bids due late Friday night. People familiar with the company say
this piece could bring in about $5 billion.
The 158-year-old financial firm was trading normally with counterparties on
Tuesday. Rival Wall Street firm Goldman Sachs Group Inc. said it was doing
business with the firm.
Lehman, one of four big independent firms remaining after the near collapse of
Bear Stearns Cos. in March, declined to comment.
The firm's situation differs markedly from that of Bear Stearns, which was
taken over earlier this year after it ran into a liquidity crisis. Unlike Bear
Stearns, Lehman has access to new Federal Reserve facilities that can provide
short-term funding when the markets won't, in addition to the ability to
exchange illiquid assets for safer securities such as Treasurys.
That makes a sudden run on an investment bank less likely than it was a few
months ago. The facilities for dealers weren't in place when Bear Stearns faced
its crisis. The Fed does not disclose which institutions are using these
facilities.
Deal Falters
Lehman's declines came after the Korea Development Bank, which has been in
talks with Lehman about a capital infusion, said Tuesday it had closed the door
on a possible deal. Discussions between Lehman and KDB ended in early August,
according to a person familiar with the talks.
KDB said Wednesday it has ended talks with the investment bank "due to
differences in transaction terms with Lehman and in consideration of the
domestic and international financial market situation." It didn't elaborate.
But persistent rumors that a deal was still possible continued to bolster the
firm's stock. The share decline helped drag down the rest of the market, which
had rallied strongly on Monday after the bailout of Fannie and Freddie.
Financial stocks tumbled more than 6%, including a 10% decline for Lehman rival
Merrill Lynch & Co. and a 14% drop for Wachovia Corp., which is also struggling
under the weight of bad mortgage loans.
By 4 p.m. Tuesday, the Dow Jones Industrial Average had shed 280 points, nearly
wiping out the 289-point gain from Monday's session. Lehman shares last swapped
hands at $7.79 each, their lowest level in 10 years.
The severe stock drop showed how skittish investors remain about Lehman, a
bond-focused firm that moved aggressively into the commercial real-estate
market and leveraged loans over the past few years, and often produced record
profits between 2004 and 2007.
As the value of those investments has unraveled, Lehman has scrambled to raise
capital to absorb the ensuing losses. Lehman's market capitalization stood
Tuesday at $6 billion, down from $37.2 billion at the start of 2008. It has
lost $4 billion in market capitalization in the past two days alone.
"It is a chicken-and-egg issue," said Tanya Azarchs, an analyst at S&P. When
Lehman looks as if it's having trouble raising capital, shares fall. When
shares fall, raising capital by selling shares gets harder. "Regardless of
whether the rumor is true or not, in a way it becomes self-fulfilling."
Markets expect that continued losses on residential and commercial mortgage
securities will force Lehman to seek still more capital than the $12 billion it
has raised already this year. The firm's capital, or its shareholders equity --
about $32 billion -- is the cushion that protects creditors from any losses on
its roughly $640 billion in assets.
Analysts are predicting the firm will lose as much as $4.6 billion and faces
several billion dollars in write-downs on its real-estate portfolio.
Bonds issued by Lehman also lost value Tuesday, pushing some of their interest
yields to more than eight percentage points above those of comparable Treasury
securities. Debt investors "are understandably worried that the Federal Reserve
and the Treasury Department don't have an unlimited appetite for bailout
transactions," Kathleen Shanley, an analyst at Gimme Credit, said in a note on
Tuesday afternoon.
In the market for credit-default swaps, where traders buy and sell private
contracts that act like insurance against debt defaults, the annual cost of
protecting $10 million of Lehman debt from default over five years jumped to
$520,000 on Tuesday afternoon, versus $325,000 on Monday, according to data
from Phoenix Partners Group. The higher cost indicates investors see a growing
risk that the firm could default on its obligations.
In March, the cost of protection on Lehman's debt briefly hit a high of
$580,000. Contracts on Bear Stearns's debt had peaked at around $820,000 before
the investment bank was taken over by J.P. Morgan Chase & Co.
Lehman's preferred shares also tumbled to new lows, a development that could
hamper the company's ability to raise additional capital by issuing more of
these hybrid stock-debt securities. One issue -- Lehman Series J preferred
shares -- fell more than 24% on Tuesday to $9.15, down from their issuance
price of around $25. Lehman pays a fixed annual dividend of 7.95% on these
shares, and their current prices reflect a yield of 16.6%, according to
PreferredsOnline, a database for U.S. preferred securities. That means that to
attract outside investors to new preferred shares, Lehman would have to pay
prohibitively expensive annual rates of 16% or more.
Rating on Review
S&P, in placing its single-A rating on Lehman on review for a downgrade, said
it might end up affirming the ratings but could also downgrade them by more
than one notch. Lehman's short-term credit ratings could also be cut, which
could affect its ability to tap money-market funds for cash in the short-term
debt and overnight repurchase agreement markets.
Adding to the turmoil: The firm, which has 24,000 employees, cut 1,000 to 1,500
jobs Tuesday, its fourth round of layoffs this year. As employees cleared out
their desks, colleagues stayed glued to television screens, watching Lehman's
share decline. Outside the company's headquarters in midtown Manhattan, one
employee, who declined to be named, said: "The market is biased against us."
Over the weekend, Lehman executives grew heartened by the government's rescue
of Fannie and Freddie. They expected the plan to soothe the markets,
particularly the battered financial sector.
Investors appeared agitated about Lehman, however, which for months has been
loath to provide details about how it would find new capital. By failing to
announce a solution before now, Lehman has backed itself into a corner.
In theory, the steep drop in its market value should make Lehman a more
attractive takeover target. A more likely scenario may be for Lehman to
continue to muddle through, using access to the Fed's discount window to
fulfill its counterparty obligations.
"Clearly the company does not believe that it has a serious balance-sheet
problem and it simply refuses to take what it believes are fire-sale prices for
its key assets," Richard Bove of Ladenburg Thalmann & Co. said before Tuesday's
stock drop. "Buyers seem to believe that Lehman is overvaluing its assets and
refuse to hit the bid."
--David Reilly, Gregory Zuckerman, Jenny Strasburg, Aaron Lucchetti, Annelena
Lobb and the Associated Press contributed to this articl
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