Lehman In Deep Trouble

Bloomberg is reporting Lehman May Report $4 Billion Writedown, JPMorgan Says.

Aug. 19 (Bloomberg) -- Lehman Brothers Holdings Inc. may write down about $4 billion in credit-related investments and other assets when it reports fiscal third-quarter earnings, JPMorgan Chase & Co. analysts said.

Lehman may mark down some of its $61 billion of mortgage and other asset-backed securities after benchmark residential and commercial mortgage-related indexes declined by as much as 20 percent, the analysts wrote.

Lehman, the largest underwriter of mortgage bonds before the subprime market collapsed, has slumped 77 percent in New York trading as it struggles to pare its debt holdings. The bank has reported writedowns and credit losses of $8.2 billion in the past 12 months, according to data compiled by Bloomberg.

The analysts cut their per-share estimate for the third quarter to a loss of $3.30 from a 35-cent profit. They expect Lehman to report a loss of $6.77 a share for the full year, compared with their earlier forecast of a $2.35 loss.

"Lehman continues to have significant exposure to mortgages and asset backed securities," JPMorgan's Worthington said in the report. "We believe management wants to leave its mortgage troubles behind and restore confidence."

Securities firms are cutting their holdings of riskier loans and selling assets to shore up capital. Lehman wants to sell 20 percent of its more than $60 billion of "distressed" assets in the third quarter, Merrill Lynch & Co. analyst Guy Moszkowski, said in a July 28 note to clients. He expects the firm to post a $2.5 billion writedown on home loans in the quarter.

The securities firm will probably retain its Neuberger Berman LLC asset-management unit, the JPMorgan analysts said. "We don't think the ratings agencies would welcome this divestiture," they added.

Unsolvable Dilemma For Lehman

Minyan Peter had a few thoughts on Lehman earlier today on Minyanville.

The rumors swelling around Lehman's (LEH) sale of commercial real estate and a stake in Neuberger Berman highlight important dilemmas for financial institutions: In order to rid themselves of troubled assets, they must find good assets to sell to offset the loss on the bad. Otherwise, they must either dramatically shrink their balance sheets or, with the hybrid market closed, issue additional common equity.

But realize, by selling the good with the bad, financial institutions are dramatically altering their future earnings potential. Further, for some firms, as credit continues to deteriorate, we will reach the point where there are no good assets left to sell.

Not saying that we are there today, or that one of those firms is Lehman. But recognize that the unwinding process is clearly underway.

Deleveraging Risk Still Growing

On August 4, in Deleveraging Risk High And Growing At Lehman I commented "There is virtually no chance that Lehman can avoid huge losses on those $65 billion in mortgage and real estate securities, I do not care what the alleged quality is compared to Merrill. There is simply little market for illiquid mortgage and real estate securities. Furthermore, the longer Lehman waits, the worse both will get, especially commercial real estate holdings. A $20 billion hit would not surprise me one bit."

Lehman raised $4 billion in capital in common equity on June 10th at $28 a share and an additional $2 billion in preferred stock. See Lehman posts loss and plans to raise capital. Clearly Lehman did not have a clue as to how much capital it would need. The same thing can be said for Citigroup (C), Merrill Lynch (MER), Washington Mutual (WM), Wachovia (WB) and others.

Every step of the way, these companies have announced the "final round" of capital raising effort only to have to go back to the well again and again.

Ironically "The hedges that Lehman had put in place to cushion potential losses from mortgage investments went wrong, adding to the red ink, rather than minimizing it." (see above link for more details).

Rising Default Risk At Lehman, Merrill Lynch, Citigroup

Credit default swaps show Rising Bond Risk On Concerns Over Bank Credit Losses.

The cost of protecting corporate bonds from default rose after analysts predicted Lehman Brothers Holdings Inc. may write down about $4 billion in assets, signaling losses at the world's largest banks and financial companies will deepen.

Credit-default swaps on Lehman and Merrill Lynch & Co. climbed to the highest in more than three weeks and contracts on Citigroup Inc., the biggest U.S. bank by assets, jumped to a five-week high.

"The worst is yet to come in the U.S.," said Rogoff, a Harvard University professor of economics. "The financial sector needs to shrink; I don't think simply having a couple of medium sized banks and a couple of small banks going under is going to do the job."

Preferred Window For Lehman Is Closed

Minyanville professor Bennet Sedacca had a few comments on Lehman today.

Lehman's benchmark preferred deal it did at 7.95% in February at 25 is now 15.5 bid for a cool 12.82% yield. So the preferred market is closed.

The debt market? Lehman's debt trades, when it trades, in the +450-500 range so I would imagine it would have to come to market in the +600 range considering where other deals have been done of late.

When the window shuts and your balance sheet erodes, you are finished. Period.

Lehman Daily Chart



click on chart for sharper image

Lehman's Choices Revisited

Assuming the preferred market is closed, when Lehman goes to raise capital it will have two choices.

• Sell Assets
• Issue Common Stock

Issuing common stock will be massively dilutive. It last did so at $28 and that was at a $4 discount to the share price at the time. Lehman is now at $13.07. And selling assets poses the problem Minyan Peter described above.

All things considered, no matter how much Lehman wants to keep hold of its Neuberger Berman asset-management unit, it is unlikely to be able to do so. Indeed there is a question if Lehman survives at all. For more on that thought please see Meredith, Can Lehman Survive This?

Lehman is in deep trouble. Like Citigroup, if Lehman somehow does survive, it will not be in one piece looking anything like it does today.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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