Lehman Loss Deepens Fears On Credit Market

By Tomoeh Murakami Tse
Washington Post Staff Writer
Tuesday, June 10, 2008

NEW YORK, June 9 -- Lehman Brothers stunned analysts Monday by reporting that it expects a quarterly loss of $2.8 billion and would raise $6 billion in capital to shore up its balance sheet, signaling that turmoil in the credit market is far from over.

After weeks of speculation about financial weakness at Wall Street's fourth-largest firm, Lehman made public its intent to raise additional money and took the unusual step of disclosing its second-quarter results a week early in an effort to assuage investors' concerns.

The firm has been plagued in recent months by questions from investors about its financial health. Some were concerned it might be headed for the same fate as another Wall Street investment bank, Bear Stearns, which nearly went bankrupt in March and was sold for a bargain-basement price to J.P. Morgan Chase in a deal hastily arranged by federal regulators. Last week, Lehman issued a statement to deny a rumor that it had turned to the Federal Reserve's discount window for emergency funds.

Lehman's estimated loss of $2.8 billion, or $5.14 per share, for its second quarter, which ended March 31, compares with profit of $1.3 billion, or $2.21 per share, a year ago. This will mark the first quarterly loss since Lehman went public in 1994 and far exceeded analysts' estimates of several hundred million dollars in losses.

The losses came as the firm wrote down the value of assets on its books and lost money from its trading activities. Lehman also took a hit as its hedges -- steps taken to protect the firm from certain losses -- failed to work. Such hedges had previously blunted the blows to Lehman's bottom line.

"I am very disappointed in this quarter's results," Lehman's chairman and chief executive Richard S. Fuld Jr. said in a statement. "Notwithstanding the solid underlying performance of our client franchise, we had our first-ever quarterly loss as a public company."

Highlighting the turbulence in financial markets, Fuld's comments provided a stark contrast to remarks he made less than two months ago, when he told investors at Lehman's annual meeting that "the worst of the impact of the financial markets is behind us."

Moody's Investors Service downgraded its outlook on Lehman Monday to negative from stable, in part, it said, because of "concerns over risk management decisions that resulted in elevated real estate exposures."

When the credit crisis began a year ago, Lehman, along with Goldman Sachs, posted relatively solid results and appeared to be weathering the tough market conditions better than some rivals. But now, Lehman seems to sharing the experience of Merrill Lynch and Citigroup, which have sought billions in fresh capital as they suffered outsize losses in mortgage-related and other securities.

Lehman's shares have suffered the steepest losses among the Wall Street investment banks this year -- down more than 50 percent -- amid questions about the firm's leverage, or borrowing levels, and the values it has put on mortgages and other assets.

In a conference call, Erin Callan, Lehman's chief financial officer, sought to dispel the notion that the firm's trading partners were worried about its financial strength.

"The discussions at this point are not about our viability, or the fact that we'll be here or the fact that we have sufficient liquidity," Callan said. "I think we put that to bed on a number of different levels through our own actions. . . . I don't think there's any question on the part of our counterparties or lenders that they will be repaid by Lehman Brothers." She also said the "ineffective hedges of the first quarter were an aberration."

The firm said it had moved aggressively during the second quarter to strengthen its financial position, for instance by reducing exposure to residential and commercial mortgages and real estate investments by up to 20 percent. It also cut its exposure to loans for mergers and acquisitions by more than a third. Lehman said it had reduced its gross leverage to 25, down from 31.7 at the end of last year, meaning the firm is now borrowing $25 for every $1 of its own money.

Callan said Lehman does not plan to reduce leverage further and intends to use the new capital to take advantage of market opportunities in the future. Lehman reported that it is raising $4 billion through common stock, at $28 a share, and $2 billion in preferred shares that will be convertible into common stock.

Despite the firm's efforts to reassure investors, the estimates of its second-quarter losses and the unexpectedly large amount of money to be raised unnerved some analysts and investors. Lehman shares closed down nearly 9 percent.

Steve Gutch, director of research at Clover Capital Management, said Lehman is not headed the way of Bear Stearns.

"The risk to the brokers is a lack of confidence from the counterparties," he said. "I don't think you have that type of risk at Lehman. . . . With the capital raise and the fact that they were able to bring down some of their less liquid assets and reduce the leverage, I think that all goes in the right direction."

Lehman plans to release the full details of its quarterly results next Monday.

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