By SUSANNE CRAIG
April 1, 2008
Lehman Brothers Holdings Inc. has unveiled its latest attempt to try to shake the shorts.
On Monday, the firm announced it plans to issue $3 billion of preferred shares, a move that will strengthen its balance sheet and that it hopes will dispel speculation that it is facing a capital crunch. The question now: Will it be enough? "I think an issue of this size with the investors we have on board will put the false rumors about our capital position to rest," said Lehman Chief Financial Officer Erin Callan.
Not everyone is on board. The Wall Street brokerage has become a favorite target of short sellers, traders who make money by betting that a stock's price will fall. The shorts now will likely ask: If Lehman had enough capital, why did it need to do the new issue, which will dilute the stakes of existing shareholders by potentially increasing shares outstanding by about 5%?
Thursday, the stock fell almost 9%. Two weeks ago, in the wake of the forced sale of Bear Stearns Cos. to J.P. Morgan Chase & Co., Lehman's stock took another nasty tumble, falling 19% to a 4½-year low. Some Lehman shareholders blamed the decline on heavy selling by short sellers, who borrow shares and sell them, hoping to buy them back at a lower price and lock in a profit.
Monday, Lehman's stock fell 23 cents to $37.64 in 4 p.m. New York Stock Exchange composite trading. But in after-hours trading, the share price declined $1.12 to $36.52. Lehman maintains that the stock will rebound once investors learn both the terms of the offering and the fact that it has been "substantially" presold. Late last night, Lehman said there was $11 billion in investor demand for its offering.
So far this year, Lehman's stock is down 43%, compared with 16% for the Dow Jones Wilshire U.S. Financial Services Index and 23% and 14%, respectively, for rivals Goldman Sachs Group Inc. and Morgan Stanley. Lehman says that over the past few months it has been trying to lower the amount of debt it takes on relative to its assets, both by selling assets and now by raising capital -- so the new offering isn't necessarily aimed at beating back the short sellers.
Still, as of March 12, there were 46.6 million shares, 9.1% of Lehman's total float, sold short. That is up from 9.4 million shares at the beginning of the year, according to the NYSE. Investors also are loading up on Lehman options, another way to bet on a fall in the firm's stock.
The firm says it has enough cash on hand to weather the current crisis, $31 billion in cash and cash equivalents and another $65 billion in assets it can easily borrow against. Furthermore, thanks to a recent change in the rules, it now has access for the first time to Federal Reserve funds, a move that gives Lehman access to an essentially unlimited pool of money at the same rate as commercial banks.
Lehman is no stranger to the skeptics. The brokerage and its chairman, Richard Fuld Jr., fought off rumors about a cash crunch in 1998 that were triggered by the near-collapse of hedge fund Long Term Capital Management. At that time, the firm hired a private-investigation firm to get to the bottom of the speculation circling the company. Since then, Mr. Fuld has won praise for diversifying Lehman, long known as a bond house, into lucrative areas like stock trading and investment banking.
This time around, the firm has publicly spoken out against the shorts. It has met with the Securities and Exchange Commission, and top management is actively trying to track down the source of rumors as they arise.
The main concern: Lehman's still-sizable exposure to the mortgage market makes it easy for critics to draw comparisons to Bear. A recent Bank of America report notes that mortgages represent 29% of total assets at Lehman, roughly in line with Bear, which had one-third of its assets in mortgages, and much higher than Merrill Lynch & Co. and Goldman Sachs, both at 12%, and 13% at Morgan Stanley. Ms. Callan estimates Lehman's total real-estate exposure is closer to 20% and it is a skilled operator in managing real-estate assets.
"Looking toward the remainder of 2008, Lehman investors will be nervously waiting to see if the firm, with its balance sheet loaded with $87 billion of troubled assets which are under pricing pressure and which can't be easily sold, will be able to navigate the continuing credit storm and the de-leveraging environment that we anticipate," wrote Brad Hintz, an analyst at Sanford C. Bernstein & Co. and a former chief financial officer at Lehman.
Nearly $31 billion of its holdings are commercial-real-estate loans. Even as it cut way back on making home loans, Lehman continued to lend to buyers of office buildings and other assets, and analysts expect it will take a hit on these this year.
A big concern is Lehman's 2007 investment in Archstone-Smith Trust, which it bought with Tishman Speyer Properties in May 2007, just as the real-estate market was beginning to melt. Lehman bought in at $60.75 a share. Archstone is now private, but shares of its publicly traded rivals are down substantially, suggesting Lehman's investment is underwater.
During a conference call to discuss its first-quarter earnings, Lehman said it currently holds $2.3 billion of Archstone's non-investment-grade debt and $2.2 billion of equity, both of which Ms. Callan said are being carried "materially below par." She said Lehman is working to sell assets and improve Archstone's financial profile. Lehman says it has taken write-downs on this investment, but the size of the haircut isn't known because it doesn't release this data on individual investments.
Lehman also has significant exposure to so-called Alt-A mortgages, which let borrowers disclose less information about their income than standard mortgages. These loans have been under increased stress in recent months as delinquencies have risen at rapid rate.
Overall, the bank has about $31.8 billion in residential-mortgage exposure and $13.5 billion is Alt-A. The firm has taken $3 billion in write-downs on the residential portfolio, a substantial portion of which was Alt-A. On this front, Lehman argues this positioned is hedged, meaning that any losses will be offset by gains elsewhere.