Next Up: Lehman Brothers?

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Includes: DBSDY, LEH
by: Mark McQueen

Investors began dumping their shares in Lehman Brothers (LEH) before the opening bell. By 7 am ET, the stock was down about 18% in premarket trading, to $32.25, and the loss grew to 28% before 8am, to $28.20. It's now down 20% in early trading.

There’s one thing you need to understand about many of the complex risk models at the various banks across North America: one of the key inputs is public company share price performance. Within the RAROC model [Risk Adjusted Return On Capital], for example, an important driver of the risk rating of a business is the action of its stock. The theory is that the stock market is a better predictor of default risk than credit agency ratings. JPMorgan (NYSE:JPM) (see prior post “JPMorgan inks the deal of the year,” March 16, 2008) is one of the key disciples of RAROC.

When credit officers turn on their computers this morning, the risk rating on Lehman Brothers will have jumped sky-high, given the performance of the stock on Friday and earlier this morning. Nothing will have changed at Lehman, but it doesn’t matter. Institutions will have no choice but to pull back their funding relationships.

South Asia’s largest bank, DBS Group Holdings (OTCPK:DBSDY), pulled its relationship with Lehman earlier this morning according to the Wall Street Journal, although once word got out an internal communication was issued, reversing the prior direction.

Moodys has stepped in to support Lehman, affirming its A1 credit rating.

We’ll see if equity investors found that to be sufficient to end the rout on Lehman.

Related: Bear's Gone - Is Lehman Next?