Lehman Shock Waves Hit European Bourses

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Lehman's Asset Sales Will Have Impact

Analysts at Keefe, Bruyette, & Woods, an investment bank that specializes in financial companies, say there are two main types of risk for European banks in the fallout from Lehman. First: counterparty risks on trades involving Lehman. It will take some time to see if problems emerge, but market participants had some time to see this one coming and may have taken precautions. Besides the actions by European central banks, the U.S. Federal Reserve has loosened lending restrictions in what appears to be a coordinated effort to calm the markets.

At a press conference in the auditorium of Lehman's gleaming tower at London's Canary Wharf, Steven Pearson, part of a team from PricewaterhouseCoopers that has taken control of Lehman's British operations, said the company "was exceptionally complex, with hundreds of billions of dollars" in outstanding assets and liabilities, mostly to trading counterparties. The PWC administrators said they had dozens of people in the Lehman building, and when they started looking at Lehman's British books they found no cash because all of the money was swept up by New York each night. While they indicated they would want some senior managers to remain in place for several months, they said there was no certainty yet that there would be funds to meet Lehman's next payday on Friday. The administrators did say the Bank of England was providing special facilities to help unwind trades.

The second worry is that fire sales of Lehman assets such as residential mortgage-backed securities and commercial real estate loans—Lehman has $17 billion and $33 billion of these, respectively—will force European banks to further mark down their portfolios of these types of securities, further unnerving investors and adding to pressure on their capital ratios. Keefe Bruyette says European banks with large investment banking arms such as Barclays, RBS, UBS (UBS), and Credit Suisse (CS) are at most risk of such markdowns. However, analysts say that regulators might give the banks breathing room on mark-to-market requirements to avoid further downward spirals.

Even on a bleak day there are some silver linings. For instance, Bank of America is paying a healthy premium for Merrill Lynch—about 70% over Sept. 12's closing share price. As likely consolidation continues, that could be good news for banks such as Credit Suisse and UBS that have solid franchises in private banking that continue to churn out healthy profits despite the investment banking turmoil.

Other Buying Opportunities?

The group of European banks that could be directly affected by the Lehman fallout is likely to be limited. Most Spanish, German, and Scandinavian institutions are "more removed" from the investment banking turmoil, Keefe Bruyette says. Adds Giorgio Questa, a veteran European banker who now teaches at London's Cass Business School: "European banks are a lot more solid" than the markets' immediate reaction would indicate. "The markets are hyperreacting," says Questa.

In addition, European banks may be in the best position to benefit from the American turmoil. Despite its share price taking a battering this year, Barclays was able to consider buying Lehman and is now ready to sign up teams of first-rate bankers from Lehman, Merrill, or other institutions who may now be looking for a home.

Old World banks, with their relatively strong balance sheets, may find themselves well-positioned to buy other distressed American assets. Now that Merrill appears to have been taken out, bankers are casting an eye at Morgan Stanley (MS), which along with Goldman Sachs (GS) is one of the last two major U.S. investment banks not attached to a behemoth such as JPMorgan Chase (JPM) or Bank of America. In today's risky world, bankers in Europe say, it is doubtful that an investment bank can stay on the playing field without the backing of a big commercial sister.

With Carol Matlack in Paris.
Reed is BusinessWeek's London bureau chief.