Lehman Brothers released their earnings report this morning at 7:30 AM. Lehman saw a Q3 loss of $5.92 a share, or $3.9 billion. There was a lot of speculation in the markets yesterday about Lehman’s liquidity after talks for an investment by KDB (Korean Development Bank) stalled and Lehman shares lost 45%. Theis at 8:00AM. Let’s see how the market responds.
See the PDF files in related articles for their results press release and financials.
The overall synopsis after listening to Dick Fuld and his financial lieutenant on the call is that Lehman has all hands on deck to keep Lehman from suffering a liquidity meltdown. They are trying to move “quickly and decisively” in order to dispel the rumors that they are on the brink of collapse.
Their core business, which they call “Core Lehman” is fairly sound. Any declines in core business can potentially be due to the swirling rumors about their stability. This sounds very similar to when Lehman last got into trouble and were sold to Shearson in 1984. It is still sound, though. Therefore, they are separating out their core business and spinning off riskier assets, especially asset-backed real estate and acquisition finance assets (which will not require shareholder approval). This should decrease leverage significantly in the core. However, they are financing this business with debt and equity, leaving them with a significant exposure nonetheless.
They have also made a lot of headcount reductions and additional cost savings. As for writedowns, note the majority of their writedowns were in Alt-A mortgages. They were unfortunately forced to make a sale of Neuberger Berman, their asset management business (IMD – Investment Management Division), although they will have a rump investment so that existing shareholders can benefit from upside in their investment.
This is a company in crisis that is doing everything it can to right the ship. Whether they will be successful in the more robust ‘Core Lehman’ depends on how the market reacts to their announcement. The spun-off assets may continue to decline, making one wonder if the debt financing of the riskier assets will be a problem down the line.
Here are details:
Commercial real estate exposure
In particular, they are looking to reduce their commercial real estate (CRE) exposure, which represents a next leg down in U.S. real estate writedowns. They are looking to separate “core Lehman Brothers” from portfolio assets of concern, particularly Commercial Real Estate.
They are going to spin off REI Global to facilitate the separation of CRE assets from core Lehman and are transferring a portfolio of assets at marked-to-market prices that reflect all existing writedowns. Lehman will capitalizing 20-25% of REI Global and will finance 80% of the debt of the spin-off. This is not a complete hands-off transaction as they want to keep some upside for Lehman shareholders. However, the debt financing is a concern about this being a true spin-off.
Note that all existing shareholders will have shares in both future companies.
Alt-A residential exposure
They are also reducing residential mortgage exposure, in particular through a disposition to Black Rock. They still will have $17 billion of overall exposure. They also have significant Alt-A exposure. However, they have made enormous markdowns to their Alt-A assets. This will put pressure on the likes of Citi and Merrill to do the same. I see a lot more writedowns in Q3 coming on the back of this. They believe that this represents “exceptionally conservative” valuations. They said it assumes U.S. home prices drop 32% peak-to-trough versus the present 18% (both non-inflation adjusted). On defaults they are only assuming 20-25% recovery rates on significant defaults in Alt-A.
Other ABS exposure
Other asset backed exposure was reduced 29%. Acquisition exposure was reduced 42%.
This represents a significant deleveraging. Core Lehman will have approximately $5 billion of CRE exposure, $10 billion of residential real estate exposure, $5 billion of other ABS exposure, and $10 in acquisition finance exposure.
Market Watch says:
Troubled investment bank to shed majority stake in Neuberger Berman, slash dividend (to five cents a share) and spin off commercial real-estate assets. Lehman shares rally in response to much-anticipated moves.
Lehman itself has said:
Lehman Brothers Holdings Inc. (ticker symbol: LEH), the global investment bank, announced today, in conjunction with its preliminary third quarter results, a comprehensive plan of initiatives to reduce dramatically the Firm’s commercial real estate and residential mortgage exposure, generate additional capital through the sale of a majority stake of the Investment Management Division and reduce the annual dividend, in order to maximize value for clients, shareholders and employees.
Chairman and Chief Executive Officer Richard S. Fuld, Jr. said, “This is an extraordinary time for our industry, and one of the toughest periods in the Firm’s history. The strategic initiatives we have announced today reflect our determination to fundamentally reposition Lehman Brothers by dramatically reducing balance sheet risk, reinforcing our focus on our client-facing businesses and returning the Firm to profitability.”
From the same PDF press release, Lehman said it has:
- Estimated Net Loss of ($3.9) Billion or ($5.92) Per Common Share (Diluted)
- Gross Mark-to-Market Adjustments of ($7.8) Billion; Net Mark-to-Market Adjustments of ($5.6) Billion, After Hedging Gains and Debt Valuation Gains. Gross Mark-to-Market Adjustments Include:
- ($5.3) Billion on Residential Mortgage-Related Positions
- ($1.7) Billion on Commercial Real Estate Positions
- Estimated Net Revenues of ($2.9) Billion
- Total Stockholders’ Equity of $28.4 Billion, Up from $26.3 Billion
- Net Leverage Ratio of 10.6x, Improved from Second Quarter of 12.1x
- Gross Leverage Reduced to 21.1x from 24.3x at the End of the Second Quarter
- Estimated Liquidity Pool of $42 Billion
- Estimated Tier 1 Ratio of Approximately 11.0%, Up From 10.7%
See the history of Lehman Brothers previous writedown-related articles in my credit crisis timeline.
Lehman Brothers Announces Preliminary 3Q Results and Strategic Restructuring – Lehman (PDF)
Lehman Q3 2008 Financial supplement – Lehman (PDF)
Lehman posts $3.9 bln loss, will sell assets – Market Watch
Fed Loans May Give Lehman Breathing Room Bear Lacked – Bloomberg
Korea Development Bank Ends Talks For Stake in Lehman – Bloomberg
Lehman stock drops 45% on capital worries – National Post
Lehman Put on Watch for Possible Downgrade by S&P – Bloomberg
Lehman Brothers Announces New Co-Heads of Investment Banking for Europe & the Middle East – Lehman (PDF)