Lehman Needs a Friend

Posted by: Matthew Goldstein on September 11, 2008

updated at 4:20 p.m. ET

Lehman Brothers appears to be coming around to the conclusion that it can’t make it alone.

Wall Street was abuzz with speculation Thursday that the beleaguered investment bank is actively talking to a number of banks and other financial firms about a possible takeover of the struggling investment house. The list of possible suitors being bandied about includes Bank of America, Barclays, Goldman Sachs, HSBC, Wells Fargo and even some private equity firms. A Lehman spokesman declined to comment on the deal talk.

The speculation about Lehman throwing in the towel comes on a day that its stock got hammered again. Shares of Lehman tumbled 41% to close at $4.23. The sell-off comes just one day after Lehman CEO Dick Fuld announced a still evolving plan to put the firm’s financial affairs in order. The stock has plummeted more than 70% this week alone.

The vicious selling is Wall Street’s way of saying it doubts Lehman CEO Dick Fuld can get the job done. Traders worry Fuld won’t be able to raise the necessary capital from the sale of a majority stake in its Neuberger Berman asset management business, to fund a new Lehman spin-off that will house some $30 billion in ailing commercial real estate assets. It’s increasingly looking like the firm’s days as an independent firm are numbered, as one analyst after another begins saying Lehman needs to find another bank to rescue it from oblivion.

And there’s a lot of fear on Wall Street that the federal government may be reluctant to step-in and actively engineer a deal for Lehman, the way the Federal Reserve did for Bear Stearns in March. That’s especially so if the only potential buyer is a foreign bank.

The list of possible domestic partners for Lehman is pretty slim. JPMorganChase still has its hands full digesting Bear. The same can be said for Bank of America, which recently closed on its deal for troubled mortgage lender Countrywide Financial. David Hendler, an analyst with CreditSights is suggesting Goldman Sachs, which has weathered the credit crunch better than any other Wall Street firm, as a possible emergency suitor. But complicating matters is the unfolding situation with Washington Mutual, the nation’s largest thrift. WaMu’s stock has been the other big casualty this week, plunging more than 40% over the past four days to around $2.80. There’s a possibility that WaMu also may need to be rescued by a bigger bank.

One concern with Lehman is its extensive book of derivative contracts—sophisticated agreements with other banks, hedge funds and financial firms that are tied to the performance of an underlying security. Investment banks, unlike commercial banks, are not required to disclose a great deal of information about derivatives. But a potential downgrade of Lehman’s debt by a rating agency could force Lehman to cough-up more money under the terms of these deals. In a regulatory filing, Lehman says it may be required to post $2.9 billion in additional collateral under these derivative contracts if its debt rating is lowered by one notch. If Lehman’s rating is lowered by two notches, it may have to come up with an additional $4.4 billion in collateral to satisfy its trading partners. Of course, the last thing Lehman can afford now is expending any more cash than it needs to.

Meanwhile, the mood inside Lehman’s Times Square office is said to be somber. Sources say many of the brokers at Lehman have listed with headhunters, trying to find new jobs. Teams of traders are putting out feelers to friends at other Wall Street firms about making a jump.