Bear dead, is Lehman Bros. next?

Mar 17, 2008 @ 1:41 pm

By Aaron Elstein

In the wake of the stunning collapse of Bear Stearns Cos., investors scrambled Monday to identify the next likely Wall Street victim of the credit crisis, according to Crain's New York Business.

Lehman Brothers Holdings Inc., which like Bear is heavily leveraged and has a big mortgage portfolio, got slammed out of the starting gate. Its shares lost over a third of their value in early trading before rebounding.

The shares were also hurt by Moody’s downgrading the brokerage house’s outlook to “stable” from “positive.”

The credit rating agency warned that the Lehman’s real estate exposure could pose a “not-insignificant burden on profitability.”

As of Nov. 30, Lehman had $80 billion of commercial mortgages on its books, the value of which is growing more dubious by the minute. Lehman was also Wall Street’s leading dealer in subprime residential mortgages for the past few years.

“Who’s Next?” asked a report Monday morning by Fox-Pitt Kelton Cochran Caronia Waller analyst David Trone. “No broker is safe,” he concluded, from the panic that caused investors to stampede out of Bear last week and brought down the 85-year-old firm, forcing it over the weekend into the arms of J.P. Morgan Chase & Co. at a fire-sale price of $2 a share.

The coming few days will also be dismal for Wall Street. Lehman, Goldman Sachs Group Inc., and Morgan Stanley are all expected to report steep declines in first-quarter profits later this week. In addition, they face challenges lining up the short-term debt they rely on to finance their day-to-day operations.

“All the brokers are going to face a funding run this week,” warned Sanford C. Bernstein & Co. analyst Brad Hintz.

Though Lehman’s stock got hit hardest on Monday, Morgan Stanley and Merrill Lynch both fell about 9%, Goldman Sachs slipped 8%, and Citigroup dropped 8%. In contrast J.P. Morgan, which is widely seen as buying Bear at a bargain-basement price, saw shares rise 9%.

Lehman will report first-quarter results tomorrow and they won’t be pretty. Analysts surveyed by Reuters Estimates expect the firm to post earnings of 73 cents a share, a 63% drop from the year-earlier period. Revenue is projected to fall by a third.

While Lehman has done its best to highlight its differences with Bear—late last week it announced that about 40 banks joined together to extend it a new $2 billion credit facility—at the moment investors seem to be focusing on their similarities. Like Bear, Lehman generates much of its revenue from bond sales and trading, and like Bear it is heavily leveraged. Lehman had $22 billion of capital and $691 billion of assets, as of Nov. 30, meaning it is leveraged to the tune of 31 times assets.

On the other hand, Morgan Stanley as of year end was leveraged 33 to one.

“Rising illiquidity across financial markets has resulted in asset concentrations on Lehman's balance sheet that have proven to be somewhat larger than optimal for the firm,” Moody’s said.

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