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Lehman Faces Another Loss, Adding Salt To Its Wounds - Wall Street Journal

August 18, 2008

By RANDALL SMITH and SUSANNE CRAIG
August 18, 2008; Page C1

Lehman Brothers Holdings Inc. has been taking its time as it wrestles with how to escape the problems haunting the investment bank. It probably can't wait much longer.

With the end of the New York company's fiscal third quarter less than two weeks away, some analysts are girding for a loss of $1.8 billion or more, instead of the modest profit they previously expected. If the dour projections come true, Lehman's losses since the start of March would total at least $4.5 billion -- or more than the firm churned out in profit during fiscal 2007.

The likelihood of back-to-back quarterly losses, fueled by widely anticipated write-downs in a portfolio saddled with more than $50 billion in risky real-estate and mortgage assets, puts even more pressure on Lehman Chairman and Chief Executive Richard S. Fuld Jr. to show that the losses won't keep piling up. If they do, Lehman could need to raise additional capital beyond the $6 billion it got in June.

In the past few months, Lehman officials have examined an array of options to bolster the company's financial position, ranging from selling troubled real-estate assets at a discount to divesting a piece of profitable asset-management unit Neuberger Berman, according to people familiar with the matter.

Another stock offering would be hard to pull off without angering existing shareholders, largely because the tidal wave of common shares floated in June has since plunged in value by 42%. Lehman shares slipped three cents, or 0.2%, to $16.17 each in New York Stock Exchange composite trading at 4 p.m. Friday.

Lehman has been working hard to reduce its exposure to assets causing it big headaches, and the firm's balance sheet shrank 19% to $639 billion in the fiscal second quarter ended May 31. Lehman is aiming to further winnow its exposure to risky assets by at least 20% a quarter, two Wall Street analysts said last week.

But those moves aren't coming fast enough to offset the misery caused by continuing stress in the housing market, where prices are falling with no end in sight. For example, Lehman holds $10.2 billion of Alt-A mortgages, or loans made to borrowers who didn't fully document their income. The firm has an additional $11.5 billion in exposure to leveraged-buyout financing.

David Trone, an analyst at Fox-Pitt, Kelton, predicts that Lehman will write down its Alt-A portfolio by about $1.7 billion, or 17%, at the end of the current quarter.

J.P. Morgan Chase & Co.'s write-down of $1.5 billion in Alt-A and other mortgages, disclosed in a securities filing last week, also prods Lehman to take its own haircut on home-loan exposure. Mortgage write-downs also might be triggered by price levels in sales related to the recent restructuring of structured investment vehicles such as Cheyne Finance PLC.

Mr. Trone expects Lehman to pile up overall write-downs of $3.6 billion, offset by $800 million in hedging gains. While that obviously would be painful, it is "not meaningful enough, in our view, to necessitate additional capital raises," Mr. Trone concludes. He expects Lehman to post a net loss of $1.8 billion, far worse than his previous estimate of a $250 million profit.

Guy Moszkowski, a Merrill Lynch & Co. analyst who last week more than doubled his loss projection to $2.6 billion, predicts that Lehman will take a $4.5 billion hit from write-downs, with about 35% of that offset by hedging. He also cut his estimates for Goldman Sachs Group Inc. and Morgan Stanley.

An additional markdown of as much as 20% related to the firm's remaining $64 billion in mortgage and commercial real-estate exposure "seems like a lot but can't be ruled out," Mr. Moszkowski argues. If that were to happen, Lehman might need to raise more capital.

Write to Randall Smith at randall.smith@wsj.com¹