Lehman: Delevering Risk High, and Growing

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Includes: C, LEH, MER
by: Michael Shedlock

Reuters is reporting Lehman may have to raise capital if sells assets.

Lehman Brothers Holdings Inc is expected to follow in Merrill Lynch & Co Inc's footsteps and sell a lot of risky assets at a loss. But shedding the assets may create another headache for Lehman -- the need to raise large amounts of new capital, including common equity.

Any capital raise would be painful for Lehman and its shareholders, given that the company just raised $6 billion in June and trades at a significant discount to its book value, or the net accounting value of its assets.

But Lehman, the fourth-largest U.S. investment bank, may have little choice as it wrestles with roughly $65 billion in mortgage-related assets, particularly after Merrill Lynch agreed to shed $30.6 billion in toxic assets at a fire-sale price of 22 cents in the dollar, analysts said.

My Comment: The myth that Merrill Lynch (MER) got 22 cents on the dollar still persists. Merrill Lynch actually got 5.5 cents on the dollar with a chance of getting more later. What Merrill accomplished was getting those nearly worthless CDOs off its balance sheet for something that at first glance appears to have been 22 cents.

Lehman had roughly $65 billion in mortgage and real estate-related assets on its balance sheet as of May 31.

Brad Hintz, an analyst at Sanford C. Bernstein, wrote in a note on Monday that any loss much greater than $1.5 billion -- which translates to selling $30 billion at a discount of at least a 5 percent to their current value on Lehman's books -- would likely force Lehman to issue at least some common equity.

My Comment: 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.

If Lehman needs to raise more capital, it may consider selling all or a portion of its asset management business, analysts said -- a move mentioned in media reports as a possibility for weeks.

Investment banks have increasingly been looking to sell assets instead of issuing shares since shedding businesses that provide a relatively low amount of revenue may be less painful for shareholders than dramatically boosting outstanding shares.

My Comment: Heaven help Lehman if it is involved in ratchet provisions to any significant degree as was Merrill Lynch (MER) and as is Washington Mutual(NYSE:WM) and Citigroup (NYSE:C).

Merrill Lynch got out from its ratchet provisions at the cost of a big writeoff as noted in Ratchet Provisions Soak Merrill Lynch, Will Sink WaMu.

Lehman's asset management unit, which includes the Neuberger Berman business that Lehman bought in 2003, generated about $1.88 billion in net revenue in 2007. Analysts estimate the unit could sell for about $8 billion.

Selling a business to raise capital may be better than issuing shares, but it is generally not pleasant, in part because getting a good price in a sale is tough now. Few buyers have the capital to make big acquisitions, and any potential acquirers know the sellers are anxious to sell assets.

Merrill Chief Executive John Thain told investors in June that he saw the Bloomberg business as worth between $5 billion and $6 billion, but the investment bank ended up selling it for less than that.

My Comment: On the same basis, figure Lehman will get less than half of what it expects for Neuberger Berman.

The other major U.S. investment banks all trade at a premium to their book value, and during better times, investment banks typically trade at twice their book value. Lehman's trading so far below book value signals that investors foresee significant future write-downs.

My Comment:  The reason Lehman is trading at less than book value is simple. Its book value is ridiculously inflated.

Deleveraging risk is high and growing, not only at Lehman, but also at Citigroup (C), Merrill Lynch (MER), and others. Neither Lehman nor Citigroup is likely to survive in their current form in my opinion. In case you missed it, check out Meredith Whitney's reply to the question Meredith, Can Lehman Survive This?

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