Lehman's Preferred Offering Is a Sign of Weakness

Add Lehman Brothers to the list of Wall Street firms that are going hat in hand for more capital in these uncertain times, when confidence is wholly absent in the marketplace. Lehman is selling at least $3bn of new shares to bolster its capital base and end any fears about a cash shortage. If the share sale goes according to plan, this will bolster its capital base.

However, just the fact that it has chosen to tap the public equity markets for $3bn speaks to the weakness of its position. If anything, this move may exacerbate fears that the bank has an extremely troubled balance sheet. This fear may persist even with a $3bn fundraising. It seems the smarter move would have been to line up a large investor or two to take convertible preferreds, or put private equity into the company like many of Lehman’s competitors have done. Those who have pursued this path have not been punished by investors, and investors are not speculating about their viability. The fact that Lehman is going into the public equity markets is another sign that makes it look weak, since it raises speculation that sovereign wealth firms took a look at the books and said 'No thanks'.

Lehman will offer 3 million convertible preferred shares. Demand for the shares was already three times greater than the amount offered as of 6:30 p.m. in New York, according to a person familiar with the offering.

"We still maintain that we don’t need capital, but we’ve realized that perception is the dominant issue in today’s markets,” Chief Financial Officer Erin Callan said in an interview. "This is an endorsement of our balance sheet by investors.” The Prince doesn’t disagree but Mssr. Callan saying they don’t need capital seems implausible and almost laughable. The CDS on Lehman has fallen, so it would appear that the credit markets believe the move makes Lehman a better credit risk. Credit-default swaps tied to Lehman’s senior unsecured bonds narrowed 15 basis points after the announcement to 285 basis points.

The fact the deal is so oversubscribed shouldn’t be surprising since it is offering such great terms. It has a coupon payment of 7 percent to 7.5 percent. The conversion premium is said to be 30 to 35 percent above the current stock price. Yet, like the Prince said earlier, the move will certainly improve the balance sheet. However restoring confidence in the firm will not be helped by the weakness this offering displays.

Disclosure: The Prince has a short position in Lehman Brothers and a net long a basket of broker dealers.