Markets & Finance

Lehman Takes a Licking


The stock sank for a second straight day on June 3 amid reports the brokerage firm will raise more capital—and market rumors about its viability

One day after investors in Lehman Brothers (LEH) had to weather a sell-off in shares of the brokerage firm, the stock tanked again. On June 3, Lehman shares fell nearly 10% on press reports that the company intended to raise $4 billion in fresh capital, stirring market worries that the credit crunch could come back with a vengeance. For some, the plunge stirred up memories of Bear Stearns' March collapse, and financial-market rumormongers wasted no time spreading the idea that the selling in Lehman shares was a prelude to a Bear-like final act for the 158-year-old firm.

The bad buzz forced Lehman treasurer Paolo Tonucci to deny that the bank had to borrow funds from the Federal Reserve's discount window lending facility on June 3.

But are things really that bad for Lehman? The bond market didn't appear to think so. If the firm were truly on the verge of extinction, its debt should have seen a sharp sell-off—but that didn't happen on June 3. "The equity investor is acting first and asking questions later," said Sanford C. Bernstein analyst Brad Hintz. "Fixed-income investors were much more sanguine."

More Downgrades?

Although Lehman will most likely be here for some time to come, its problems are many—and big. Start with the June 2 downgrade of Lehman's credit rating by Standard & Poor's, which reduced Lehman's debt to A from A+. The downgrade had little real immediate impact—"Lehman's debt was already trading as if the downgrade had already occurred," Gimme Credit analyst Kathleen Shanley said in a June 3 report. The fact that Lehman's rating was left on negative watch by S&P raised fears of more downgrades to come.

The June 3 sell-off also could be chalked up to the fact that a capital infusion involving the sale of a big chunk of new Lehman common stock could dilute shareholder equity. Lehman has already raised $7.9 billion in debt via the sale of preferred shares and will have to turn to the equity markets if, as is expected, they seek additional cash. "They've reached the limit as directed by ratings agency of how much hybrid debt and preferreds they can have," says Lauren Smith, an analyst at Keefe, Bruyette & Woods (KBW). The number could be as high as $4 billion in common equity, The Wall Street Journal recently reported, equal to nearly one-quarter of Lehman's current market cap.

Troubled Times Ahead

Investors should expect Lehman to be in for a long, tough slog. In lowering Lehman's debt rating, Standard & Poor's said it expects a "meaningful deterioration in Lehman's second-quarter performance." The equity analyst community appears to agree, having recently reduced estimates for the company's second-quarter earnings, expected June 16. Analysts now expect the firm to post a quarterly profit of 12¢ a share, down 9¢ from their consensus forecast of early May.

Lehman's profitable equity and international businesses should create a buffer that didn't exist for Bear, analysts say, but with the asset-backed securities market at a standstill (except in low-margin mortgages from Fannie Mae and Freddie Mac), and a slowing U.S. economy doing its domestic business no favors, it will take Lehman a while to recover. "The environment remains dicey [for a recovery]," Keefe, Bruyette & Woods' Smith said.

Then of course, there's the credit crunch. If nothing else, Lehman's nosedive is proof that the problems facing U.S. investment banks are far from over. Analysts expect Lehman to post more writedowns—though not necessarily of the magnitude of those in the first quarter—amid lingering credit problems. "We thought all along this situation will take longer to fix," says Thomas Atteberry, co-manager of First Pacific Advisors. "If I were Lehman, I would raise the capital while I can."

Levisohn is a staff editor at BusinessWeek covering finance and personal finance.

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